Abstract-This study presents an ANWSER model (asset network systemic risk model) to quantify the risk of financial contagion which manifests itself in a financial crisis. The transmission of financial distress is governed by a heterogeneous interbank credit network and an investment portfolio of banks. Bankruptcy reproductive ratio of a financial system is computed as a function of the diversity and risk exposure of an investment portfolio of banks, and the denseness and concentration of a heterogeneous interbank credit network. An analytic solution of the bankruptcy reproductive ratio for a small financial system is derived and a numerical solution for a large financial system is obtained. For a large financial system, large diversity among banks in the investment portfolio makes financial contagion more damaging on the average. But large diversity is essentially effective in eliminating the risk of financial contagion in the worst case of financial crisis scenarios. A bank-unique specialization portfolio is more suitable than a uniform diversification portfolio and a system-wide specialization portfolio in strengthening the robustness of a financial system.
Abstract-It had been believed in the conventional practice that the risk of a bank going bankrupt is lessened in a straightforward manner by transferring the risk of loan defaults. But the failure of American International Group in 2008 posed a more complex aspect of financial contagion. This study presents an extension of the asset network systemic risk model (ANWSER) to investigate whether credit default swaps mitigate or intensify the severity of financial contagion. A protection buyer bank transfers the risk of every possible debtor bank default to protection seller banks. The empirical distribution of the number of bank bankruptcies is obtained with the extended model. Systemic capital buffer ratio is calculated from the distribution. The ratio quantifies the effective loss absorbency capability of the entire financial system to force back financial contagion. The key finding is that the leverage ratio is a good estimate of a systemic capital buffer ratio as the backstop of a financial system. The risk transfer from small and medium banks to big banks in an interbank network does not mitigate the severity of financial contagion.
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keywords: bank, balance sheet, capital surcharge, credit network, equity capital ratio, knock-on default SummaryThis study presents a computer simulation model to analyze the risk of transmission of financial distress in a bank credit network and the knock-on defaults of banks. The impact is quantified, which is imposed on the number of defaults by the topology of the bank credit network, the balance sheet of banks including equity capital ratio, and the capital surcharge on big banks.
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