Contagion in the Interbank Market with Stochastic Loss Given Default

Abstract

This paper investigates contagion in the German interbank market under the assumption of a stochastic loss given default (LGD). We combine a unique data set about the LGD of interbank loans with detailed data about interbank exposures. We find that the frequency distribution of the LGD is markedly u-shaped. Our simulations show that contagion in the German interbank market is not unlikely. Furthermore, we find that taking into account banks ’ off-balance sheet exposures has a remarkable effect on the results of the contagion analysis.

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