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Systemic Risk in Financial Networks

Wednesday 17 March 2021

Both leverage and interconnectedness are widely recognized as key factors for systematic risk and may interact. The magnitude of network-based amplification of distress depends on financial exposure network structure and maybe crucially influenced for example by the presence of destabilising feedback loops in an exposure network. It has been shown that the number of feedback loops in a network, as well as the eigenvalues of associated matrices, are related to a structural property called trophic coherence. In this paper, we investigate the impact of trophic coherence on systematic risk - measured using DebtRank - and its interaction with leverage in simulated networks of banks connected to each other by direct exposures. The mechanism is simple: when a bank suffers a loss, distress propagates to its creditors, who in turn suffer losses, and so on. We show that trophic coherence has a crucial influence on contagion dynamics: shock amplification is moderated even at high leverage in more coherent networks; and high even where leverage is low in incoherent networks. This result not only suggests that it may be worthwhile to monitor the trophic coherence of financial networks; but also implies that in principle systematic risk could be significantly reduced simply by "rewiring" the interbank network (without any increase in capital requirements or reduction in interbank loans). We propose a simple strategy to incentivise the self-organised formation of more coherent network structures without impairing market functionality.

Bio Dr Bazil Sansom - Applied economist with research interests primarily in macroeconomics, housing markets and topics in macro-finance. The main research interests are to understand economic fluctuations including business cycle dynamics and financial market volatility and crises. Employing a range of methods from complex networks, dynamical systems theory and signal processing, with a strong empirical emphasis.

Current areas of active research include

  • Production networks - structure and dynamical phenomena
  • Financial networks with an emphasis on liquidity and clearing
  • Housing market instability
  • International business cycle dynamics
  • Firms in macroeconomic dynamics
  • Sectoral and regional aspects of aggregate fluctuations