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A flow network analysis of direct balance-sheet contagion in financial networks

  • Mario Eboli
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    This 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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    File URL: https://www.ifw-members.ifw-kiel.de/publications/a-flow-network-analysis-of-direct-balance-sheet-contagion-in-financial-networks/1862_KWP.pdf
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    Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1862.

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    Length: 40 pages
    Date of creation: Aug 2013
    Date of revision:
    Handle: RePEc:kie:kieliw:1862
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    1. Mistrulli, Paolo Emilio, 2011. "Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1114-1127, May.
    2. Dow, James, 2000. "What Is Systemic Risk? Moral Hazard, Initial Shocks, and Propagation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 18(2), pages 1-24, December.
    3. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-62, November.
    4. Christian Upper, 2007. "Using counterfactual simulations to assess the danger of contagion in interbank markets," BIS Working Papers 234, Bank for International Settlements.
    5. Gale, Douglas & Kariv, Shachar, 2003. "Bayesian learning in social networks," Games and Economic Behavior, Elsevier, vol. 45(2), pages 329-346, November.
    6. Xavier Freixas & Bruno Parigi & Jean Charles Rochet, 1998. "Systemic risk, interbank relations and liquidity provision by the Central Bank," Economics Working Papers 440, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 1999.
    7. Rodrigo Cifuentes & Gianluigi Ferrucci & Hyun Song Shin, 2005. "Liquidity risk and contagion," Bank of England working papers 264, Bank of England.
    8. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2008. "Network models and financial stability," Bank of England working papers 346, Bank of England.
    9. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
    10. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
    11. Hojman, Daniel & Szeidl, Adam, 2006. "Core and Periphery in Endogenous Networks," Working Paper Series rwp06-022, Harvard University, John F. Kennedy School of Government.
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