# 14-098/II (2014-07-28; 2016-08-11)

Marco van der Leij, University of Amsterdam, De Nederlandsche Bank, the Netherlands; Daan in 't Veld, University of Amsterdam, the Netherlands; Cars Hommes, University of Amsterdam, the Netherlands
financial networks, core periphery structure, network formation models, over-the-counter markets, interbank market
JEL codes:
D85, G21, L14

Recent empirical evidence suggests that financial networks exhibit a core-periphery network structure. This paper aims at giving an explanation for the emergence of such a structure using network formation theory. We propose a simple model of the overnight interbank lending market, in which banks compete for intermediation benefits. Focusing on the role of bank heterogeneity, we find that a core-periphery network cannot be unilaterally stable when banks are homogeneous. A core-periphery network structure can form endogenously, however, if we allow for heterogeneity among banks in size. Moreover, size heterogeneity may arise endogenously if payoffs feed back into bank size.