Network models of financial systemic risk: a review

Abstract

The global financial system can be represented as a large complex network in which banks, hedge funds and other financial institutions are interconnected to each other through visible and invisible financial linkages. Recently, a lot of attention has been paid to the understanding of the mechanisms that can lead to a breakdown of this network. This can happen when the existing financial links turn from being a means of risk diversification to channels for the propagation of risk across financial institutions. In this review article, we summarize recent developments in the modeling of financial systemic risk. We focus, in particular, on network approaches, such as models of default cascades due to bilateral exposures or to overlapping portfolios, and we also report on recent findings on the empirical structure of interbank networks. The current review provides a landscape of the newly arising interdisciplinary field lying at the intersection of several disciplines, such as network science, physics, engineering, economics, and ecology.

A Note on Uniqueness of Clearing Prices in Financial Systems

“…The dependencies within the network may cause shocks to spread by contagion, and lead to a cascade of defaults -if not (again) prevented by public institutions. See for instance the overview of Glasserman and Young (2016) or Caccioli et al (2018) which try to disentangle the problem by discussing various ways correlations between nodes in the financial system play a role. In this paper we will further investigate the rather simple yet seminal model of a financial system due to Eisenberg and Noe (2001).…”

Quantifying the importance of different contagion channels as sources of systemic risk

“…Other contributions on the quantification of contagion effects include Upper and Worms (2004), Degryse and Nguyen (2007) and Cont et al (2013). Upper (2011) provides a good overview of many of these approaches, and Caccioli et al (2018) provide a more recent review. There also exists a rich literature studying fire sales alone, without the added contribution contagion effects from bilateral exposures.…”

Modeling Overlapped Mutual Funds’ Portfolios: A Bipartite Network Approach

“…The complexity of the mutual funds network, measured by the diversity index (vdiversity), as in the case of diversification, is dependent on industry-specific variables and the funds' investment management variables. Column (7) shows that there is a positive relation between diversity, the book-to-market ratio (ln book), turnover (ln to), and the active share (ln as) of the mutual funds. Of these three variables related to the financial management of the funds, the one that has the greatest impact is the book-to-market ratio ( = 0.51, normalized coefficient).…”

“…Accordingly, Table 3 shows models that evaluate the consistency of the previous results, controlling for the possible effects of the financial crisis of 2008. All models include a dummy variable (dum crisis) that takes the value of 1 for each month in the period from Oct-07 to Oct-09 and zero otherwise 7 . The idea is to corroborate that our results are not the result of the financial turmoil that occurred during that time.…”

“…The study of the phenomenon of systemic risk through overlapping portfolios is novel [4,7]; however, there is a lack of studies applied to the mutual fund industry, despite its importance and size 2 . Delpini and others [8] analyze the bipartite network of US mutual funds during the financial crisis, studying how the systemic fragility of the system depends on the overlap between portfolios.…”