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Systemic cascades on inhomogeneous random financial networks

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  • T. R. Hurd

    (McMaster University)

Abstract

This article presents a model of the financial system as an inhomogeneous random financial network (IRFN) with N nodes that represent different types of institutions such as banks or funds and directed weighted edges that signify counterparty relationships between nodes. The onset of a systemic crisis is triggered by a large exogenous shock to banks’ balance sheets. Their behavioural response is modelled by a cascade mechanism that tracks the propagation of damaging shocks and possible amplification of the crisis, and leads the system to a cascade equilibrium. The mathematical properties of the stochastic framework are investigated for the first time in a generalization of the Eisenberg–Noe solvency cascade mechanism that accounts for fractional bankruptcy charges. New results include verification of a “tree independent cascade property” of the solvency cascade mechanism, and culminate in an explicit recursive stochastic solvency cascade mapping conjectured to hold in the limit as the number of banks N goes to infinity. It is shown how this cascade mapping can be computed numerically, leading to a rich picture of the systemic crisis as it evolves toward the cascade equilibrium.

Suggested Citation

  • T. R. Hurd, 2023. "Systemic cascades on inhomogeneous random financial networks," Mathematics and Financial Economics, Springer, volume 17, number 1, March.
  • Handle: RePEc:spr:mathfi:v:17:y:2023:i:1:d:10.1007_s11579-022-00315-7
    DOI: 10.1007/s11579-022-00315-7
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    References listed on IDEAS

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    Cited by:

    1. Giuseppe Calafiore & Giulia Fracastoro & Anton Proskurnikov, 2024. "Default Resilience and Worst-Case Effects in Financial Networks," Papers 2403.10631, arXiv.org.

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