Contagion in Financial Networks
TL;DR: The authors developed an analytical model of contagion in financial networks with arbitrary structure and explored how the probability and potential impact of contagions is influenced by aggregate and idiosyncratic shocks, changes in network structure, and asset market liquidity.
Abstract: This paper develops an analytical model of contagion in financial networks with arbitrary structure. We explore how the probability and potential impact of contagion is influenced by aggregate and idiosyncratic shocks, changes in network structure, and asset market liquidity. Our findings suggest that financial systems exhibit a robust-yet-fragile tendency: while the probability of contagion may be low, the effects can be extremely widespread when problems occur. And we suggest why the resilience of the system in withstanding fairly large shocks prior to 2007 should not have been taken as a reliable guide to its future robustness.
Citations
More filters
TL;DR: This work offers a comprehensive review on both structural and dynamical organization of graphs made of diverse relationships (layers) between its constituents, and cover several relevant issues, from a full redefinition of the basic structural measures, to understanding how the multilayer nature of the network affects processes and dynamics.
2,669 citations
TL;DR: Drawing analogies with the dynamics of ecological food webs and with networks within which infectious diseases spread, the interplay between complexity and stability in deliberately simplified models of financial networks is explored.
Abstract: In the run-up to the recent financial crisis, an increasingly elaborate set of financial instruments emerged, intended to optimize returns to individual institutions with seemingly minimal risk. Essentially no attention was given to their possible effects on the stability of the system as a whole. Drawing analogies with the dynamics of ecological food webs and with networks within which infectious diseases spread, we explore the interplay between complexity and stability in deliberately simplified models of financial networks. We suggest some policy lessons that can be drawn from such models, with the explicit aim of minimizing systemic risk.
1,237 citations
TL;DR: In this paper, the authors develop a network model of interbank lending in which unsecured claims, repo activity and shocks to the haircuts applied to collateral assume centre stage, and show how systemic liquidity crises of the kind associated with the interbank market collapse of 2007-2008 can arise within such a framework, with funding contagion spreading widely through the web of interlinkages.
778 citations
Cites methods from "Contagion in Financial Networks"
...4We build on Gai and Kapadia (2010, 2011) who model default contagion and liquidity hoarding by adapting techniques advanced by Newman et al (2001) and Watts (2002)....
[...]
TL;DR: In this article, the authors model contagions and cascades of failures among organizations linked through a network of financial interdependencies and identify how the network propagates discontinuous changes in asset values triggered by failures.
Abstract: We model contagions and cascades of failures among organizations linked through a network of financial interdependencies. We identify how the network propagates discontinuous changes in asset values triggered by failures (e.g., bankruptcies, defaults, and other insolvencies) and use that to study the consequences of integration (each organization becoming more dependent on its counterparties) and diversification (each organization interacting with a larger number of counterparties). Integration and diversification have different, nonmonotonic effects on the extent of cascades. Initial increases in diversification connect the network which permits cascades to propagate further, but eventually, more diversification makes contagion between any pair of organizations less likely as they become less dependent on each other. Integration also faces tradeoffs: increased dependence on other organizations versus less sensitivity to own investments. Finally, we illustrate some aspects of the model with data on European debt cross-holdings.
760 citations
Additional excerpts
...Gai and Kapadia (2010) made two observations....
[...]
TL;DR: The recent financial crisis has highlighted the need to go beyond a purely micro approach to financial regulation and supervision and the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably.
Abstract: The recent financial crisis has highlighted the need to go beyond a purely micro approach to financial regulation and supervision. As a consequence, the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably. The policy debate is focusing in particular on macroprudential tools and their usage, their relationship with monetary policy, their implementation and their effectiveness. Macroprudential policy has recently also attracted considerable attention among researchers. This paper provides an overview of research on this topic. We also identify important future research questions that emerge from both the literature and the current policy debate.
732 citations
Cites background from "Contagion in Financial Networks"
...31 Fourth, the resilience of the financial system depends in a non-linear fashion on its network connectivity: while the likelihood of contagion may be reduced by greater connectivity, the potential impact of a shock has a much larger scale (Gai and Kapadia, 2010; Nier et al., 2008)....
[...]
...…institution.31 Fourth, the resilience of the financial system depends in a non-linear fashion on its network connectivity: while the likelihood of contagion may be reduced by greater connectivity, the potential impact of a shock has a much larger scale (Gai and Kapadia, 2010; Nier et al., 2008)....
[...]
References
More filters
TL;DR: It is found that scale-free networks, which include the World-Wide Web, the Internet, social networks and cells, display an unexpected degree of robustness, the ability of their nodes to communicate being unaffected even by unrealistically high failure rates.
Abstract: Many complex systems display a surprising degree of tolerance against errors. For example, relatively simple organisms grow, persist and reproduce despite drastic pharmaceutical or environmental interventions, an error tolerance attributed to the robustness of the underlying metabolic network1. Complex communication networks2 display a surprising degree of robustness: although key components regularly malfunction, local failures rarely lead to the loss of the global information-carrying ability of the network. The stability of these and other complex systems is often attributed to the redundant wiring of the functional web defined by the systems' components. Here we demonstrate that error tolerance is not shared by all redundant systems: it is displayed only by a class of inhomogeneously wired networks, called scale-free networks, which include the World-Wide Web3,4,5, the Internet6, social networks7 and cells8. We find that such networks display an unexpected degree of robustness, the ability of their nodes to communicate being unaffected even by unrealistically high failure rates. However, error tolerance comes at a high price in that these networks are extremely vulnerable to attacks (that is, to the selection and removal of a few nodes that play a vital role in maintaining the network's connectivity). Such error tolerance and attack vulnerability are generic properties of communication networks.
7,697 citations
"Contagion in Financial Networks" refers background in this paper
...It would be useful to extend the simulation analysis by relaxing the assumption that the defaulting bank is randomly selected and, along the lines of Albert et al. (2000), considering the implications of targeted failure affecting big or highly connected interbank borrowers....
[...]
Book•
11 Jul 1991
TL;DR: This book discusses the biology of host-microparasite associations, dynamics of acquired immunity heterogeneity within the human community indirectly transmitted helminths, and the ecology and genetics of hosts and parasites.
Abstract: Part 1 Microparasites: biology of host-microparasite associations the basic model - statics static aspects of eradication and control the basic model - dynamics dynamic aspects of eradication and control beyond the basic model - empirical evidence of inhomogeneous mixing age-related transmission rates genetic heterogeneity social heterogeneity and sexually transmitted diseases spatial and other kinds of heterogeneity endemic infections in developing countries indirectly transmitted microparasites. Part 2 Macroparasites: biology of host-macroparasite associations the basic model - statics the basic model - dynamics acquired immunity heterogeneity within the human community indirectly transmitted helminths experimental epidemiology parasites, genetic variability, and drug resistance the ecology and genetics of host-parasite associations.
7,675 citations
TL;DR: This work aims to understand how an enormous network of interacting dynamical systems — be they neurons, power stations or lasers — will behave collectively, given their individual dynamics and coupling architecture.
Abstract: The study of networks pervades all of science, from neurobiology to statistical physics. The most basic issues are structural: how does one characterize the wiring diagram of a food web or the Internet or the metabolic network of the bacterium Escherichia coli? Are there any unifying principles underlying their topology? From the perspective of nonlinear dynamics, we would also like to understand how an enormous network of interacting dynamical systems-be they neurons, power stations or lasers-will behave collectively, given their individual dynamics and coupling architecture. Researchers are only now beginning to unravel the structure and dynamics of complex networks.
7,665 citations
"Contagion in Financial Networks" refers background or methods in this paper
...Our paper takes up this challenge by introducing techniques from the literature on complex systems (Strogatz, 2001) into a nancial system setting....
[...]
...We illustrate the robust-yet-fragile tendency of nancial systems and analyse how contagion risk changes with capital bu¤ers, the 5See Strogatz (2001) and Newman (2003) for authoritative and accessible surveys....
[...]
TL;DR: It is demonstrated that in some cases random graphs with appropriate distributions of vertex degree predict with surprising accuracy the behavior of the real world, while in others there is a measurable discrepancy between theory and reality, perhaps indicating the presence of additional social structure in the network that is not captured by the random graph.
Abstract: Recent work on the structure of social networks and the internet has focused attention on graphs with distributions of vertex degree that are significantly different from the Poisson degree distributions that have been widely studied in the past. In this paper we develop in detail the theory of random graphs with arbitrary degree distributions. In addition to simple undirected, unipartite graphs, we examine the properties of directed and bipartite graphs. Among other results, we derive exact expressions for the position of the phase transition at which a giant component first forms, the mean component size, the size of the giant component if there is one, the mean number of vertices a certain distance away from a randomly chosen vertex, and the average vertex-vertex distance within a graph. We apply our theory to some real-world graphs, including the worldwide web and collaboration graphs of scientists and Fortune 1000 company directors. We demonstrate that in some cases random graphs with appropriate distributions of vertex degree predict with surprising accuracy the behavior of the real world, while in others there is a measurable discrepancy between theory and reality, perhaps indicating the presence of additional social structure in the network that is not captured by the random graph.
3,655 citations
TL;DR: This paper shows that a large class of standard epidemiological models, the so-called susceptible/infective/removed (SIR) models can be solved exactly on a wide variety of networks.
Abstract: The study of social networks, and in particular the spread of disease on networks, has attracted considerable recent attention in the physics community. In this paper, we show that a large class of standard epidemiological models, the so-called susceptible/infective/removed (SIR) models can be solved exactly on a wide variety of networks. In addition to the standard but unrealistic case of fixed infectiveness time and fixed and uncorrelated probability of transmission between all pairs of individuals, we solve cases in which times and probabilities are nonuniform and correlated. We also consider one simple case of an epidemic in a structured population, that of a sexually transmitted disease in a population divided into men and women. We confirm the correctness of our exact solutions with numerical simulations of SIR epidemics on networks.
3,138 citations
"Contagion in Financial Networks" refers methods in this paper
...Contagion in Financial Networks 7 Our approach has some similarities to the epidemiological literature on the spread of disease in networks (see, for example, Pastor-Satorras and Vespignani, 2001, Newman, 2002, Jackson and Rogers, 2007, or the overview by Meyers, 2007)....
[...]