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Intermediation in the Interbank Lending Market
This paper studies systemic risk in the interbank market. We first establish that in the German interbank lending market, a few large banks intermediate funding flows between many smaller periphery banks and that shocks to these intermediary banks in the financial crisis spill over to the activities of the periphery banks. We then develop a network model in which banks trade off the costs and benefits of link formation to explain these patterns. The model is structurally estimated using banks’ preferences as revealed by the observed network structure in the precrisis period. It explains why ...