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Network versus portfolio structure in financial systems

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  • Teruyoshi Kobayashi

    () (Graduate School of Economics, Kobe University)

Abstract

The 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 dilemma h, 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 ginfectiveness h 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.

Suggested Citation

  • Teruyoshi Kobayashi, 2013. "Network versus portfolio structure in financial systems," Discussion Papers 1307, Graduate School of Economics, Kobe University.
  • Handle: RePEc:koe:wpaper:1307
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    Cited by:

    1. Christoph Siebenbrunner, 2017. "Clearing algorithms and network centrality," Papers 1706.00284, arXiv.org.
    2. Fabio Caccioli & Paolo Barucca & Teruyoshi Kobayashi, 2017. "Network models of financial systemic risk: A review," Discussion Papers 1719, Graduate School of Economics, Kobe University.
    3. Kobayashi, Teruyoshi, 2014. "A model of financial contagion with variable asset returns may be replaced with a simple threshold model of cascades," Economics Letters, Elsevier, vol. 124(1), pages 113-116.
    4. Teruyoshi Kobayashi & Kohei Hasui, 2013. "Efficient immunization strategies to prevent financial contagion," Papers 1308.0652, arXiv.org, revised Dec 2013.

    More about this item

    Keywords

    Systemic risk; financial crisis; financial network; macro-prudential policy;

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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