Optimal portfolio for a robust financial system

Abstract

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.

Dynamic Contagion of Systemic Risk in an Endogenous Banking System

“…Some studies have been conducted based on multiple channels including interbank loans and external investment [38][39][40][41]. However, most of the results are drawn without considering the dynamic features of the banking system.…”

“…erefore, the lending scale of a bank can be defined by its in-degree and out-degree proportionally. According to Maeno et al [39], the interbank loan from bank i to bank s can be expressed as follows:…”

Impact of credit default swaps on financial contagion

“…Systemic risk [2] is rather intensified. This study presents an extension of the asset network systemic risk model (ANWSER) [4], [10] to investigate whether the CDS 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.…”