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, Beal et al. (gIndividual versus systemic risk and the regulator's dilemmah, 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 ginfectivenessh 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 collective defaults. The introduction of a counteractive portfolio structure will significantly reduce systemic risk.
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Bibliographic InfoPaper provided by Graduate School of Economics, Kobe University in its series Discussion Papers with number 1307.
Date of creation: Apr 2013
Date of revision:
Systemic risk; financial crisis; financial network; macro-prudential policy;
Other versions of this item:
- Teruyoshi Kobayashi, 2013. "Network versus portfolio structure in financial systems," Papers 1308.0773, arXiv.org.
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-05-11 (All new papers)
- NEP-BAN-2013-05-11 (Banking)
- NEP-NET-2013-05-11 (Network Economics)
- NEP-RMG-2013-05-11 (Risk Management)
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- Teruyoshi Kobayashi, 2013.
"A model of financial contagion with variable asset returns may be replaced with a simple threshold model of cascades,"
- 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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