Network versus portfolio structure in financial systems
AbstractThe question of how to stabilize financial systems has attracted considerable attention since the global financial crisis of 2007-2009. Recently, Beale et al. ("Individual versus systemic risk and the regulator's dilemma", Proc Natl Acad Sci USA 108: 12647-12652, 2011) demonstrated that higher portfolio diversity among banks would reduce systemic risk by decreasing the risk of simultaneous defaults at the expense of a higher likelihood of individual defaults. In practice, however, a bank default has an externality in that it undermines other banks' balance sheets. This paper explores how each of these different sources of risk, simultaneity risk and externality, contributes to systemic risk. The results show that the allocation of external assets that minimizes systemic risk varies with the topology of the financial network as long as asset returns have negative correlations. In the model, a well-known centrality measure, PageRank, reflects an appropriately defined "infectiveness" of a bank. An important result is that the most infective bank need not always be the safest bank. Under certain circumstances, the most infective node should act as a firewall to prevent large-scale collective defaults. The introduction of a counteractive portfolio structure will significantly reduce systemic risk.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1308.0773.
Date of creation: Aug 2013
Date of revision:
Publication status: Published in European Physical Journal B, 86 10 (2013) 434
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Web page: http://arxiv.org/
Other versions of this item:
- Teruyoshi Kobayashi, 2013. "Network versus portfolio structure in financial systems," Discussion Papers 1307, Graduate School of Economics, Kobe University.
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-08-10 (All new papers)
- NEP-BAN-2013-08-10 (Banking)
- NEP-NET-2013-08-10 (Network Economics)
- NEP-RMG-2013-08-10 (Risk Management)
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- Kobayashi, Teruyoshi, 2014.
"A model of financial contagion with variable asset returns may be replaced with a simple threshold model of cascades,"
Elsevier, vol. 124(1), pages 113-116.
- Teruyoshi Kobayashi, 2013. "A model of financial contagion with variable asset returns may be replaced with a simple threshold model of cascades," Papers 1312.6804, arXiv.org, revised Apr 2014.
- Teruyoshi Kobayashi, 2013. "A model of financial contagion with variable asset returns may be replaced with a simple threshold model of cascades," Discussion Papers 1315, Graduate School of Economics, Kobe University.
- Teruyoshi Kobayashi & Kohei Hasui, 2013. "Efficient immunization strategies to prevent financial contagion," Papers 1308.0652, arXiv.org, revised Dec 2013.
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