Contagion in Chinese Banking System: A Comparison of Maximum Entropy Method and Transfer Entropy Method

Abstract

Maximum entropy method (MEM) is the traditional approach to estimate interbank exposure matrix, which is the key to assess contagion effect in banking system. Recently, a new transfer entropy method (TEM) is proposed to estimate interbank exposure matrix. This paper employs the two approaches to estimate interbank exposure matrix of Chinese banking system, and then simulate the contagion process given the initial failure of a bank in the system. The comparison of the results indicate that MEM is consistent with TEM when it comes to general and qualitative features of Chinese banking system; while the differences begin to emerge when it comes to the exact and quantitative features of Chinese banking system.