Realized Random Graphs, with an Application to the Interbank Network

Abstract We introduce a new inferential methodology for dynamic network models driven by latent state variables. The main idea is to obtain a noisy representation of the state variables dynamics by computing a sequence of cross-sectional estimates of the network model at each point in time. The dynamic modeling of these cross-sectional estimates, that we name realized random graphs, transforms the original nonlinear state-space network model into a linear time-series model that can be easily estimated. Under the assumption of a mixed-membership blockmodel structure, the model parameters and the unobservable state variables can be consistently estimated when both the size of the network and the time-series length are large. By allowing for an extremely rich parameterization of the model in high dimensions, the proposed methodology describes the heterogeneous topology of real-world networks. We corroborate our findings by using this novel framework to estimate and forecast the dynamic common factors driving the evolution of the Italian electronic market of interbank deposits, and we show that the interbank lending rate is a key factor determining the network topology.