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Risk trading, network topology and banking regulation

  • Stefan Thurner
  • Rudolf Hanel
  • Stefan Pichler
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    In the context of understanding the nature of the risk transformation process of the financial system we propose an iterative risk-trading game between several agents who build their trading strategies based on a general utility setting. The game is studied numerically for different network topologies. Consequences of topology are shown for the wealth time-series of agents, for the safety and efficiency of various types of network. The proposed set-up allows an analysis of the effects of different approaches to banking regulation as currently suggested by the Basle Committee of Banking Supervision. We find a phase-transition-like phenomenon, where the Basle parameter plays the role of temperature and system safety serves as the order parameter. This result suggests the existence of an optimal regulation parameter. As a consequence, a tightening of the current regulatory framework does not necessarily lead to an improvement of the safety of the banking system. Moreover, we show that banking systems with local risk-sharing cooperations have higher global default rates than systems with low cyclicality.

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    Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

    Volume (Year): 3 (2003)
    Issue (Month): 4 ()
    Pages: 306-319

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    Handle: RePEc:taf:quantf:v:3:y:2003:i:4:p:306-319
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