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On the Computational Complexity of Measuring Global Stability of Banking Networks

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  • Piotr Berman
  • Bhaskar DasGupta
  • Lakshmi Kaligounder
  • Marek Karpinski
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    Abstract

    Threats on the stability of a financial system may severely affect the functioning of the entire economy, and thus considerable emphasis is placed on the analyzing the cause and effect of such threats. The financial crisis in the current and past decade has shown that one important cause of instability in global markets is the so-called financial contagion, namely the spreading of instabilities or failures of individual components of the network to other, perhaps healthier, components. This leads to a natural question of whether the regulatory authorities could have predicted and perhaps mitigated the current economic crisis by effective computations of some stability measure of the banking networks. Motivated by such observations, we consider the problem of defining and evaluating stabilities of both homogeneous and heterogeneous banking networks against propagation of synchronous idiosyncratic shocks given to a subset of banks. We formalize the homogeneous banking network model of Nier et al. and its corresponding heterogeneous version, formalize the synchronous shock propagation procedures, define two appropriate stability measures and investigate the computational complexities of evaluating these measures for various network topologies and parameters of interest. Our results and proofs also shed some light on the properties of topologies and parameters of the network that may lead to higher or lower stabilities.

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    File URL: http://arxiv.org/pdf/1110.3546
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1110.3546.

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    Date of creation: Oct 2011
    Date of revision: Mar 2013
    Handle: RePEc:arx:papers:1110.3546

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    Web page: http://arxiv.org/

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    1. Franklin Allen & Douglas Gale, 1999. "Financial Contagion," Levine's Working Paper Archive 2092, David K. Levine.
    2. Roger D. Lagunoff & Stacey L. Schreft, 1998. "A model of financial fragility," Research Working Paper 98-01, Federal Reserve Bank of Kansas City.
    3. Basab Dasgupta, 2004. "Capital Accumulation in the Presence of Informal Credit Contracts: Does the Incentive Mechanism Work Better than Credit Rationing Under Asymmetric Information?," Working papers 2004-32, University of Connecticut, Department of Economics.
    4. Freixas, Xavier & Parigi, Bruno & Rochet, Jean Charles, 1999. "Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank," CEPR Discussion Papers 2325, C.E.P.R. Discussion Papers.
    5. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2008. "Network models and financial stability," Bank of England working papers 346, Bank of England.
    6. Krishnamurthy, Arvind, 2000. "Comment on Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 639-40, August.
    7. F.R. Liedorp & L. Medema & M. Koetter & R.H. Koning & I. van Lelyveld, 2010. "Peer monitoring or contagion? Interbank market exposure and bank risk," DNB Working Papers 248, Netherlands Central Bank, Research Department.
    8. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
    9. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
    10. Ana Babus, 2006. "The Formation of Financial Networks," Tinbergen Institute Discussion Papers 06-093/2, Tinbergen Institute.
    11. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
    12. Douglas M. Gale & Shachar Kariv, 2007. "Financial Networks," American Economic Review, American Economic Association, vol. 97(2), pages 99-103, May.
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