Densely Entangled Financial Systems

In [1] Zawadoski introduces a banking network model in which the asset and counter-party risks are treated separately and the banks hedge their assets risks by appropriate OTC contracts. In his model, each bank has only two counter-party neighbors, a bank fails due to the counter-party risk only if at least one of its two neighbors default, and such a counter-party risk is a low probability event. Informally, the author shows that the banks will hedge their asset risks by appropriate OTC contracts, and, though it may be socially optimal to insure against counter-party risk, in equilibrium banks will {\em not} choose to insure this low probability event. In this paper, we consider the above model for more general network topologies, namely when each node has exactly 2r counter-party neighbors for some integer r>0. We extend the analysis of [1] to show that as the number of counter-party neighbors increase the probability of counter-party risk also increases, and in particular the socially optimal solution becomes privately sustainable when each bank hedges its risk to at least n/2 banks, where n is the number of banks in the network, i.e., when 2r is at least n/2, banks not only hedge their asset risk but also hedge its counter-party risk.Comment: to appear in Network Models in Economics and Finance, V. Kalyagin, P. M. Pardalos and T. M. Rassias (editors), Springer Optimization and Its Applications series, Springer, 201

Preferencial growth: exact solution of the time dependent distributions

We consider a preferential growth model where particles are added one by one to the system consisting of clusters of particles. A new particle can either form a new cluster (with probability q) or join an already existing cluster with a probability proportional to the size thereof. We calculate exactly the probability \Pm_i(k,t) that the size of the i-th cluster at time t is k. We analyze the asymptotics, the scaling properties of the size distribution and of the mean size as well as the relation of our system to recent network models.Comment: 8 pages, 4 figure

Whither Capitalism? Financial externalities and crisis

As with global warming, so with financial crises – externalities have a lot to answer for. We look at three of them. First the financial accelerator due to ‘fire sales’ of collateral assets -- a form of pecuniary externality that leads to liquidity being undervalued. Second the ‘risk- shifting’ behaviour of highly-levered financial institutions who keep the upside of risky investment while passing the downside to others thanks to limited liability. Finally, the network externality where the structure of the financial industry helps propagate shocks around the system unless this is checked by some form of circuit breaker, or ‘ring-fence’. The contrast between crisis-induced Great Recession and its aftermath of slow growth in the West and the rapid - and (so far) sustained - growth in the East suggests that successful economic progress may depend on how well these externalities are managed

Sources of pro-cyclicality in east Asian financial systems

Procyclicality is a normal feature of economic systems, but financial sector weaknesses can exacerbate it sufficiently to pose a threat to macroeconomic and financial stability. These include shortcomings in bank risk management and governance, in supervision and in terms of dependence on volatile sources of funds. The paper tests econometrically for the importance of such features leading to pro-cyclicality in the financial systems of 11 East Asian countries. This analysis makes it possible to identify specific policy measures for East Asian countries that could limit the extent to which financial systems exacerbate pro-cyclicality