Abstract:

We present a model to study financial contagion within the Chinese banking system based on balance sheet data of listed Chinese banks. Focusing on the price channel of fire sales, we calibrate demand curves of multiple asset classes to Chinese data and model banks’ optimization problem in fire sales in response to different constraints. Our simulation results show that an external shock can generate significant contagion effects within the Chinese banking sector in a non-linear fashion, and individual bank’ optimal behavior ex ante may amplify financial contagion within the banking system. In addition, the increase in the proportion of fixed income assets in total bank assets and the lack of market liquidity of financial assets are major factors contributing to financial contagion risks in China.

Full Text(PDF): A Quantitative Study on Financial Contagion — A simulation based on the Chinese banking sector data