Distress and systemic risk in financial networks
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1 Distress and systemic risk in financial networks Stefano Battiston, UZH SRC Lunch Time Seminar. LSE December 3, 2013
2 Acknowledgments Swiss National Fund, Institute of Banking and Finance, UZH (from Nov. 1st 2013) SNF Professorship at IBF, UZH - Financial Networks and Systemic risk
3 Acknowledgments Swiss National Fund, Institute of Banking and Finance, UZH (from Nov. 1st 2013) SNF Professorship at IBF, UZH - Financial Networks and Systemic risk FOC - Forecasting Financial Crises (EU FET-OPEN, ) Coordinator G. Caldarelli, 14 partners, including ECB. Tools from network science for financial regulation SIMPOL: Financial Systems Simulation and Policy Modeling (EU FET-OPEN, ) Coordinator S. Battiston, 6 partners, collaborations central banks, innovations, climate, crowdsourcing.
4 Acknowledgments Swiss National Fund, Institute of Banking and Finance, UZH (from Nov. 1st 2013) SNF Professorship at IBF, UZH - Financial Networks and Systemic risk FOC - Forecasting Financial Crises (EU FET-OPEN, ) Coordinator G. Caldarelli, 14 partners, including ECB. Tools from network science for financial regulation SIMPOL: Financial Systems Simulation and Policy Modeling (EU FET-OPEN, ) Coordinator S. Battiston, 6 partners, collaborations central banks, innovations, climate, crowdsourcing. INET - Financial Stability Program directed by J. Stiglitz. WG on Financial Networks - Chair A. Haldane Political economy aspects of fin. stability
5 Research Agenda Teaming up network scientists, economists and regulators [Galbiati 2013 Nat Phys; Battiston 2013 Nat Phys]
6 Research Agenda Teaming up network scientists, economists and regulators [Galbiati 2013 Nat Phys; Battiston 2013 Nat Phys] Characterizing financial network structure ownership, TNC [Glattfelder 2010 PRE; Vitali 2011 PLoS-ONE] e-mid, interbank, TARGET2 [Delpini 2013 Sci Rep; Di Iasio 2013 WP; Galbiati 2013 Nat Phys] derivatives (BuBa) [Roukny 2013 progr.]
7 Research Agenda Teaming up network scientists, economists and regulators [Galbiati 2013 Nat Phys; Battiston 2013 Nat Phys] Characterizing financial network structure ownership, TNC [Glattfelder 2010 PRE; Vitali 2011 PLoS-ONE] e-mid, interbank, TARGET2 [Delpini 2013 Sci Rep; Di Iasio 2013 WP; Galbiati 2013 Nat Phys] derivatives (BuBa) [Roukny 2013 progr.] Reconstructing financial networks: Time series, partial info [Kaushik 2013 PLoS-ONE; Puliga 2013 Nat Phys],[Musmeci 2013 JOSS]
8 Research Agenda Teaming up network scientists, economists and regulators [Galbiati 2013 Nat Phys; Battiston 2013 Nat Phys] Characterizing financial network structure ownership, TNC [Glattfelder 2010 PRE; Vitali 2011 PLoS-ONE] e-mid, interbank, TARGET2 [Delpini 2013 Sci Rep; Di Iasio 2013 WP; Galbiati 2013 Nat Phys] derivatives (BuBa) [Roukny 2013 progr.] Reconstructing financial networks: Time series, partial info [Kaushik 2013 PLoS-ONE; Puliga 2013 Nat Phys],[Musmeci 2013 JOSS] Distress propagation: systemic risk vs diversification [Battiston 2012 JEDC; Battiston 2012 JFS; Vitali 2013 JEBO rev.; Tasca 2012] Optimal architectures vs cascades and market illiquidity [Roukny 2013 Sci Rep]
9 Research Agenda Teaming up network scientists, economists and regulators [Galbiati 2013 Nat Phys; Battiston 2013 Nat Phys] Characterizing financial network structure ownership, TNC [Glattfelder 2010 PRE; Vitali 2011 PLoS-ONE] e-mid, interbank, TARGET2 [Delpini 2013 Sci Rep; Di Iasio 2013 WP; Galbiati 2013 Nat Phys] derivatives (BuBa) [Roukny 2013 progr.] Reconstructing financial networks: Time series, partial info [Kaushik 2013 PLoS-ONE; Puliga 2013 Nat Phys],[Musmeci 2013 JOSS] Distress propagation: systemic risk vs diversification [Battiston 2012 JEDC; Battiston 2012 JFS; Vitali 2013 JEBO rev.; Tasca 2012] Optimal architectures vs cascades and market illiquidity [Roukny 2013 Sci Rep] Indicators for policy: DebtRank: SIFI [Battiston 2012 Sci Rep.]; Controllability [Delpini 2013 Sci Rep; Galbiati 2013 Nat Phys]
10 Risk in Network Context Extending credit + trading credit implies to measure and price default risk Feasible if we assume a bank is isolated Challenging if banks are in a network of liabilities (even more with derivative contracts) Issues: e.g. under(over)-estimating risk due to network effects, amplifications, multiple equilibria
11 Ex-Ante vs Ex-Post Distress Ex-post Goal: Assess systemic impact of shock on given asset class or bank; design more resilient architecture Methods and Literature Shock is known. Stress testing, fix point default cascade: Eisenberg-Noe 2001; Elsinger ea. 2006; Gai-Kapadia 2010; Cifuentes ea Homogenous networks: Battiston ea JFS; heterogenous networks and optimal architecture: (Roukny ea Sci Rep) Compute monetary value of systemic impact: Battiston ea Sci Rep (DebtRank) Findings Diversification can be detrimental No single optimal topology, it depends on liquidity and correlation capital-centrality Go beyond default-only: Systemic impact can be estimated even in absence of defaults; there is more than just size.
12 Ex-Ante vs Ex-Post Distress Ex-ante Goal: Characterize evolution of distress, measures of distance to default, default probability in system context Methods Merton framework and Cox, with default at intermediate time. Continuous time, stochastic [Liaisons Dangereuses, Battiston 2012 JEDC; Tasca 2012 WPa,b] Two-stage, stochastic, fix point approach [in progr.] Findings Interior optimal diversification (contract density) Private incentives towards over-connectedness Complexity hampers systemic default assessment
13 Perspectives (In)efficiency of equilibrium financial networks Building on [ Koenig ea JEBO, 2012 GEB] Strategic interaction and moral hazard: concentration, complexity, interconnectedness Games and meta-games, sustainability.
14 PART I Computing impact in system context Deterministic, dynamic Ex-post refs. Battiston, S., Puliga, M., Kaushik, R., Tasca, P. and Caldarelli, G. DebtRank: Too Central to Fail? Financial Networks, the FED and Systemic Risk. Sci. Rep. 2, (2012). Battiston ea. J. Fin. Stability (2012) Roukny, T., Bersini, H., Pirotte, H., Caldarelli, G., Battiston, S. Default Cascades in Complex Networks: Topology and Systemic Risk. Sci. Rep. 3, (2013).
15 Default Cascade
16 Default Cascade
17 Default Cascade
18 Default Cascade
19 Beyond Default-only Cascades Question 1. What is the most resilient network architecture? Question 2. Given an architecture, who is most systemically important?
20 Beyond Default-only Cascades Question 1. What is the most resilient network architecture? Question 2. Given an architecture, who is most systemically important? PROBLEM with stress tests: cascades almost never occur unless Additional externalities at work : expectations : e.g. fire-sales, credit runs, market procyclicality, illiquidity (see talks by Tarik; Irena) Distress propagation before default: valuation issue e.g. DebtRank - [Battiston, Delli Gatti, Gallegati, Greenwald, Stiglitz, Default Cascades... (2012) JFS] - [Roukny, Bersini, Pirotte, Caldarelli, Battiston, Default Cascades... (2013) Sci Rep.] - [Tasca, Battiston (2012), Market Procyclicality and Systemic Risk ETH RC] - [Battiston, Puliga, Kaushik, Tasca, Caldarelli, DebtRank: Too-central-to-fail? (2012) Sci. Rep. 2:541]
21 Run of Short Term Lenders
22 Run of Short Term Lenders
23 Run of Short Term Lenders
24 What Optimal Network Architecture?
25 Bottom Line Necessary to analyse phase diagram to locate in which regime the system is/could be
26 Bottom Line Necessary to analyse phase diagram to locate in which regime the system is/could be 1 There is no single topology that is just superior 2 The most robust architecture depends on: 1 market liquidity 2 types of shocks 3 correlations btw capital buffer and degree 3 This story should not come as a surprise, but it is analyzed now systematically
27 Devaluation Effect
28 Devaluation Effect
29 Devaluation Effect
30 Devaluation Effect
31 Distress Propagation: DebtRank
32 Distress Propagation: DebtRank
33 Distress Propagation: DebtRank
34 Shock to a Common External Asset
35 Shock to a Common External Asset
36 Shock to a Common External Asset
37 DebtRank monetary value of systemic loss overcomes limitations of state-of-the art: e.g. default-only, eigenvec. centrality [Battiston, Puliga, Kaushik, Tasca, Caldarelli, DebtRank: Too-central-to-fail? (2012) Sci Rep. 2:541]
38 DebtRank monetary value of systemic loss overcomes limitations of state-of-the art: e.g. default-only, eigenvec. centrality [Battiston, Puliga, Kaushik, Tasca, Caldarelli, DebtRank: Too-central-to-fail? (2012) Sci Rep. 2:541]
39 DebtRank 1 Default Cascade Impact Time (days) monetary value of systemic loss overcomes limitations of state-of-the art: e.g. default-only, eigenvec. centrality [Battiston, Puliga, Kaushik, Tasca, Caldarelli, DebtRank: Too-central-to-fail? (2012) Sci Rep. 2:541]
40 DebtRank 1 Eigenvector Centrality monetary value of systemic loss overcomes limitations of state-of-the art: e.g. default-only, eigenvec. centrality Time (days) [Battiston, Puliga, Kaushik, Tasca, Caldarelli, DebtRank: Too-central-to-fail? (2012) Sci Rep. 2:541]
41 DebtRank 1 DebtRank monetary value of systemic loss overcomes limitations of state-of-the art: e.g. default-only, eigenvec. centrality Time (days) [Battiston, Puliga, Kaushik, Tasca, Caldarelli, DebtRank: Too-central-to-fail? (2012) Sci Rep. 2:541]
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