Contagion in Financial Networks

Abstract

The recent financial crisis has prompted much new research on the interconnectedness of the modern financial system and the extent to which it contributes to systemic fragility. Network connections diversify firms' risk exposures, but they also create channels through which shocks can spread by contagion. We review the extensive literature on this issue, with the focus on how network structure interacts with other key variables such as leverage, size, common exposures, and short-term funding. We discuss various metrics that have been proposed for evaluating the susceptibility of the system to contagion and suggest directions for future research. (JEL D85, E44, G01, G21, G22, G23, G28)

What is the Minimal Systemic Risk in Financial Exposure Networks?

“…This phenomenon should be further clarified. Non-monotonic behaviour of systemic risk as a function of link density has been observed in the literature (Nier et al, 2007;Gai and Kapadia, 2010;Glasserman and Young, 2016).…”

Analyzing credit risk transmission to the nonfinancial sector in Europe: A network approach

“…Our empirical framework thus separates contagion risk from a second form of systemic risk: the common exposure to shocks in financial markets or the macroeconomy (De Bandt, Hartmann, & Peydró, ; European Central Bank, ). Moreover, by focusing on idiosyncratic dependencies of CDS returns, our empirical strategy is closer to the theoretical concept of financial networks in which the origin of contagion is a shock to an individual institution that is subsequently transmitted to other institutions through the web of obligations (Glasserman & Young, ).…”

Crowded Trades, Market Clustering, and Price Instability

“…Market clustering might be an example of an existing market structure that can amplify seemingly unimportant events into wide-spread market volatility. In case market clusters coincide with otherwise interconnected institutions, for example banks, common asset devaluation can be a crucial default contagion channel, as suggested in recent interdisciplinary research (Tsatskis, 2012;Glasserman and Young, 2016;Levy-Carciente et al, 2015).…”

“…Market clustering might be an example of an existing market structure that can amplify seemingly unimportant events into wide-spread market volatility. In case market clusters coincide with otherwise interconnected institutions, for example banks, common asset devaluation can be a crucial default contagion channel, as suggested in recent interdisciplinary research (Tsatskis, 2012;Glasserman and Young, 2016;Levy-Carciente et al, 2015).Market clustering is expected to cause price shocks, because it amplifies the effect of existing sources of price fluctuations. More specifically, market clustering is expected to increase the chance of price shocks in two different situations: Firstly, when the order deluge due to the group behaviour overwhelms the supply (Stein, 2009;Braun-Munzinger et al, 2018) and, secondly, when the supply is thin due to the homogeneity of the investors' pool, i.e.…”