A flow network analysis of direct balance-sheet contagion in financial networks
AbstractThis paper puts forward a novel approach to the analysis of direct contagion in financial networks. Financial systems are here represented as flow networks -i.e., directed and weighted graphs endowed with source nodes and sink nodes – and the propagation of losses and defaults, originated by an exogenous shock, is here represented as a flow that crosses such a network. In establishing existence and uniqueness of such a flow function, we address a know problem of indeterminacy that arise, in financial networks, from the intercyclicity of payments. Sufficient and necessary conditions for uniqueness are pinned down. We embed this result in an algorithm that, while computing the propagation caused by a shock, controls for the emergence of possible indeterminacies. We then apply some properties of network flows to investigate the relation between the structures of a financial network-i.e. the size and the pattern of obligations - and its exposure to default contagion
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Bibliographic InfoPaper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1862.
Length: 40 pages
Date of creation: Aug 2013
Date of revision:
systemic risk; financial contagion; financial networks; flow networks;
Find related papers by JEL classification:
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- G01 - Financial Economics - - General - - - Financial Crises
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-08-23 (All new papers)
- NEP-CMP-2013-08-23 (Computational Economics)
- NEP-GTH-2013-08-23 (Game Theory)
- NEP-NET-2013-08-23 (Network Economics)
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