Reconstruction of financial network for robust estimation of systemic risk
AbstractIn this paper we estimate the propagation of liquidity shocks through interbank markets when the information about the underlying credit network is incomplete. We show that techniques such as Maximum Entropy currently used to reconstruct credit networks severely underestimate the risk of contagion by assuming a trivial (fully connected) topology, a type of network structure which can be very different from the one empirically observed. We propose an efficient message-passing algorithm to explore the space of possible network structures, and show that a correct estimation of the network degree of connectedness leads to more reliable estimations for systemic risk. Such algorithm is also able to produce maximally fragile structures, providing a practical upper bound for the risk of contagion when the actual network structure is unknown. We test our algorithm on ensembles of synthetic data encoding some features of real financial networks (sparsity and heterogeneity), finding that more accurate estimations of risk can be achieved. Finally we find that this algorithm can be used to control the amount of information regulators need to require from banks in order to sufficiently constrain the reconstruction of financial networks.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1109.6210.
Date of creation: Sep 2011
Date of revision: Feb 2012
Publication status: Published in J. Stat. Mech. (2012) P03011
Contact details of provider:
Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-09 (All new papers)
- NEP-BAN-2011-10-09 (Banking)
- NEP-CBA-2011-10-09 (Central Banking)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Paolo Emilio Mistrulli, 2007.
"Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns,"
Temi di discussione (Economic working papers)
641, Bank of Italy, Economic Research and International Relations Area.
- Mistrulli, Paolo Emilio, 2011. "Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1114-1127, May.
- Furfine, Craig H, 2003. " Interbank Exposures: Quantifying the Risk of Contagion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 111-28, February.
- Degryse, H.A. & Nguyen, G., 2006.
"Interbank Exposures: An Empirical Examination of Contagion Risk in the Belgian Banking System,"
2006-016, Tilburg University, Tilburg Law and Economic Center.
- Hans Degryse & Grégory Nguyen, 2007. "Interbank Exposures: An Empirical Examination of Contagion Risk in the Belgian Banking System," International Journal of Central Banking, International Journal of Central Banking, vol. 3(2), pages 123-171, June.
- Leonardo Bargigli, 2013. "Statistical Equilibrium Models for Sparse Economic Networks," Working Papers - Economics wp2013_25.rdf, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators).
If references are entirely missing, you can add them using this form.