RDP 2018-01: A Density-based Estimator of Core/Periphery Network Structures: Analysing the Australian Interbank Market 8. Conclusion

This paper has both a theoretical and an empirical contribution. For our theoretical contribution, we evaluated the accuracy of several commonly used estimators of core/periphery network structures and found them to be highly inaccurate in networks that have either a relatively large or relatively small core. This is particularly problematic because the core is what we are trying to determine, so the extent of the inaccuracies is typically not known a priori.

We analytically derive the source of this inaccuracy, and derive a new estimator – the density-based estimator – that is designed to overcome this problem. In numerical simulations, our estimator outperformed the commonly used estimators.

For our empirical contribution, we applied our density-based estimator to the IBOC market. We found that the 2007–08 financial crisis had a large and long-lasting effect on the market: the core shrank; the remaining core reduced their exposure to the periphery; and the periphery switched from being net borrowers to net lenders (consistent with models of precautionary liquidity demand).

One possible explanation for these long-lasting effects is that it may be less costly for the periphery to preserve their current lending relationships than to let these relationships lapse and try to renew them in a future crisis. Moreover, to the extent that there are fixed costs associated with large changes in market dynamics, it is possible that another large shock would be required for the market to revert to its previous state. Determining why temporary changes can have long-lasting consequences for the structure and functioning of interbank markets is left for future research.

From an operational perspective, there are two important conclusions. First, that we should not be complacent if the IBOC market's structure seems robust to shocks, because some of these relationships may quickly evaporate during periods of stress. And second, that temporary shocks can have long-lasting implications for the market. This is important not only for predicting the effect of future crises, but also for determining the effect of any operational changes (i.e. even temporary changes in the RBA's operations may have a long-lasting effect on this market).