33 research outputs found
Default cascades in complex networks: Topology and systemic risk
The recent crisis has brought to the fore a crucial question that remains still open: what would be the optimal architecture of financial systems? We investigate the stability of several benchmark topologies in a simple default cascading dynamics in bank networks. We analyze the interplay of several crucial drivers, i.e., network topology, banks' capital ratios, market illiquidity, and random vs targeted shocks. We find that, in general, topology matters only-but substantially-when the market is illiquid. No single topology is always superior to others. In particular, scale-free networks can be both more robust and more fragile than homogeneous architectures. This finding has important policy implications. We also apply our methodology to a comprehensive dataset of an interbank market from 1999 to 2011
The price of complexity in financial networks
Financial institutions form multilayer networks by engaging in contracts with each other and by holding exposures to common assets. As a result, the default probability of one institution depends on the default probability of all of the other institutions in the network. Here, we show how small errors on the knowledge of the network of contracts can lead to large errors in the probability of systemic defaults. From the point of view of financial regulators, our findings show that the complexity of financial networks may decrease the ability to mitigate systemic risk, and thus it may increase the social cost of financial crises
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Network Centrality and Funding Rates in the e-MID Interbank Market
This paper empirically investigates the role of banks' network centrality in the interbank market on their funding rates. Specifically we analyze transaction data from the e-MID market, the only electronic interbank market in the Euro Area and US, over the period 2006-2009 that encompasses the global financial crisis. We show that interbank spreads are significantly affected by both local and global measures of connectedness. The effects of network centrality increased as the financial crisis evolved. Local measures show that having more links increases borrowing costs for borrowers and reduces premia for lenders. For global network centrality, borrowers receive a significant discount if they increase their intermediation activity and become more central, while lenders pay in general a premium (i.e. receive lower rates) for centrality. This provides evidence of the `too-interconnected-to-fail' hypothesis
Systemic Risk: Fire-Walling Financial Systems Using Network-Based Approaches
The latest financial crisis has painfully revealed the dangers arising from a
globally interconnected financial system. Conventional approaches based on the
notion of the existence of equilibrium and those which rely on statistical
forecasting have seen to be inadequate to describe financial systems in any
reasonable way. A more natural approach is to treat financial systems as
complex networks of claims and obligations between various financial
institutions present in an economy. The generic framework of complex networks
has been successfully applied across several disciplines, e.g., explaining
cascading failures in power transmission systems and epidemic spreading. Here
we review various network models addressing financial contagion via direct
inter-bank contracts and indirectly via overlapping portfolios of financial
institutions. In particular, we discuss the implications of the
"robust-yet-fragile" nature of financial networks for cost-effective regulation
of systemic risk.Comment: 19 pages, 7 figure
The Price of Complexity in Financial Networks
Financial institutions form multi-layer networks of contracts among each other and exposures to common assets. As a result, the default probability of one institution depends on the default probability of all the other institutions in the network. Here, we show how small errors on the knowledge of the network of contracts can lead to large errors on the probability of systemic defaults. From the point of view of financial regulators, our findings show that the complexity of financial networks may decrease our ability to mitigate systemic risk and thus it may increase the social cost of financial crises