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DebtRank-transparency: Controlling systemic risk in financial networks

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  • Stefan Thurner
  • Sebastian Poledna
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    Abstract

    Banks in the interbank network can not assess the true risks associated with lending to other banks in the network, unless they have full information on the riskiness of all the other banks. These risks can be estimated by using network metrics (for example DebtRank) of the interbank liability network which is available to Central Banks. With a simple agent based model we show that by increasing transparency by making the DebtRank of individual nodes (banks) visible to all nodes, and by imposing a simple incentive scheme, that reduces interbank borrowing from systemically risky nodes, the systemic risk in the financial network can be drastically reduced. This incentive scheme is an effective regulation mechanism, that does not reduce the efficiency of the financial network, but fosters a more homogeneous distribution of risk within the system in a self-organized critical way. We show that the reduction of systemic risk is to a large extent due to the massive reduction of cascading failures in the transparent system. An implementation of this minimal regulation scheme in real financial networks should be feasible from a technical point of view.

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    File URL: http://arxiv.org/pdf/1301.6115
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1301.6115.

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    Date of creation: Jan 2013
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    Handle: RePEc:arx:papers:1301.6115

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    Web page: http://arxiv.org/

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    Cited by:
    1. Poledna, Sebastian & Thurner, Stefan & Farmer, J. Doyne & Geanakoplos, John, 2014. "Leverage-induced systemic risk under Basle II and other credit risk policies," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 199-212.

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