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Liability Concentration and Systemic Losses in Financial Networks

Author

Listed:
  • Agostino Capponi

    () (Industrial Engineering and Operations Research Department, Columbia University, New York, New York 10027)

  • Peng-Chu Chen

    () (School of Industrial Engineering, Purdue University, West Lafayette, Indiana 47906)

  • David D. Yao

    () (Industrial Engineering and Operations Research Department, Columbia University, New York, New York 10027)

Abstract

The objective of this study is to develop a majorization-based tool to compare financial networks with a focus on the implications of liability concentration. Specifically, we quantify liability concentration by applying the majorization order to the liability matrix that captures the interconnectedness of banks in a financial network. We develop notions of balancing and unbalancing networks to bring out the qualitatively different implications of liability concentration on the system’s loss profile. We illustrate how to identify networks that are balancing or unbalancing, and we make connections to interbank structures identified by empirical research, such as perfect and imperfect tiering schemes. An empirical analysis of the network formed by the banking sectors of eight representative European countries suggests that the system is either unbalancing or close to it, persistently over time. This empirical finding, along with the majorization results, supports regulatory policies aiming at limiting the size of gross exposures to individual counterparties.

Suggested Citation

  • Agostino Capponi & Peng-Chu Chen & David D. Yao, 2016. "Liability Concentration and Systemic Losses in Financial Networks," Operations Research, INFORMS, vol. 64(5), pages 1121-1134, October.
  • Handle: RePEc:inm:oropre:v:64:y:2016:i:5:p:1121-1134
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    File URL: http://dx.doi.org/10.1287/opre.2015.1402
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    Citations

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    Cited by:

    1. Nils Detering & Thilo Meyer-Brandis & Konstantinos Panagiotou & Daniel Ritter, 2018. "Financial Contagion in a Generalized Stochastic Block Model," Papers 1803.08169, arXiv.org.
    2. Tathagata Banerjee & Alex Bernstein & Zachary Feinstein, 2018. "Dynamic Clearing and Contagion in Financial Networks," Papers 1801.02091, arXiv.org, revised May 2018.
    3. Tathagata Banerjee & Zachary Feinstein, 2018. "Impact of Contingent Payments on Systemic Risk in Financial Networks," Papers 1805.08544, arXiv.org.
    4. Zachary Feinstein & Weijie Pang & Birgit Rudloff & Eric Schaanning & Stephan Sturm & Mackenzie Wildman, 2017. "Sensitivity of the Eisenberg-Noe clearing vector to individual interbank liabilities," Papers 1708.01561, arXiv.org, revised Jul 2018.

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