What is the Minimal Systemic Risk in Financial Exposure Networks?

Abstract

Management of systemic risk in financial markets is traditionally associated with setting (higher) capital requirements for market participants. There are indications that while equity ratios have been increased massively since the financial crisis, systemic risk levels might not have lowered, but even increased (see ECB data 1 ; SRISK time series 2 ). It has been shown that systemic risk is to a large extent related to the underlying network topology of financial exposures. A natural question arising is how much systemic risk can be eliminated by optimally rearranging these networks and without increasing capital requirements. Overlapping portfolios with minimized systemic risk which provide the same market functionality as empirical ones have been studied by Pichler et al. (2018). Here we propose a similar method for direct exposure networks, and apply it to cross-sectional interbank loan networks, consisting of 10 quarterly observations of the Austrian interbank market. We show that the suggested framework rearranges the network topology, such that systemic risk is reduced by a factor of approximately 3.5, and leaves the relevant economic features of the optimized network and its agents unchanged. The presented optimization procedure is not intended to actually re-configure interbank markets, but to demonstrate the huge potential for systemic risk management through rearranging exposure networks, in contrast to increasing capital requirements that were shown to have only marginal effects on systemic risk . Ways to actually incentivize a self-organized formation toward optimal network configurations were introduced in Thurner and Poledna (2013) and Poledna and Thurner (2016). For regulatory policies concerning financial market stability the knowledge of minimal systemic risk for a given economic environment can serve as a benchmark for monitoring actual systemic risk in markets.

How Does Capital Account Liberalization Affect Systemic Financial Risks? Evidence from China

“…Financial systemic risk is any existential threat to the general stability of the financial system [10]. From the perspective of fluctuation range, in addition, systemic financial risks cover a wide range of influence: they not only influence the internal part of financial system but also cause weakness of macroeconomy and reduce social welfare because of overflow effect [11,12].…”

Wealth Rheology

“…Many ideas behind agent-based modelling have been derived from concepts like kinetic theory [ 17 , 18 ], scattering [ 19 ], rate equations [ 20 ], random matrix theory [ 21 , 22 ], Brownian motion [ 23 ] which were developed in statistical physics. Using this type of ideas, one was able to model wealth or income distributions [ 24 ], dynamics of wealth inequality [ 25 , 26 ], wealth concentration [ 27 ], structure emergence [ 28 , 29 ], economic instability and corruption mechanisms [ 30 , 31 , 32 ], systemic risk in economic networks [ 33 ], emergence of heavy tails in wealth and income distributions [ 24 , 34 ], and herding behaviour [ 35 ], or to analyse statistical behaviour or rational agents [ 36 ].…”