Introduction Network Insights Surveillance Open issues Measuring systemic risk in financial networks: Progress and challenges Stefano Battiston University of Zurich Workshop on Systemic risk and regulatory market risk measures Parmenides Found. Pullach, 2 June 2014 Stefano Battiston Measuring systemic risk in financial networks: Progress and challe
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Introduction Network Insights Surveillance Open issues
Measuring systemic risk in financial networks:Progress and challenges
Stefano Battiston
University of Zurich
Workshop on Systemic risk and regulatory market risk measuresParmenides Found. Pullach, 2 June 2014
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Acknowledgments
Swiss National Fund, Inst. of Banking and Finance, UZH
SNF Professorship at IBF, UZH - Financial Networks andSystemic risk
EU-FET SIMPOL 2013-2016 www.simpolproject.eu
Financial Systems Simulations and Policy Modeling
Networks of complex fin. instruments and shadow,climate-finance and networks of influence on regulation process
EU-FET FOC 2010-2014 www.focproject.eu
Forecasting Financial Crises
Network tools for financial regulation
INET - Financial Stability Program (dir. by Stiglitz)
WG on Financial Networks - (chair Haldane)Political economy aspects of fin. stability
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Connectedness / Risk diversificationOptimal structure of the banking systemIndicators for SIFI and systemic impactHow do we contain systemic risk?International nexus of TBTF institutionsSurveillance
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Issues on Systemic Risk Measures
open questions
estimate the probability of shocks in the futurestructural breaks
VAR and ES are likely to be heavily underestimated
VAR and ES do not account interdependence. No analyticalsolution. Numerical work.VAR of a bank in isolation differs from VAR of a bank in anetworksystemic VAR of a network of interconnected banks from VARof aggregated system
Risk measures are blind1 to asset overvaluation2 network effects3 procyclical effects
risk: the whole exercise might give new but false sense ofsecurity
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
The Financial System as a Network
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
The Financial System as a Network
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
The Financial System as a Network
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
The Financial System as a Network
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
The Financial System as a Network
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Financial Networks: Levels of Analysis
1 Static level, descriptive topology, across countries and legalsettings
2 Simplified agent behaviour: response to shocks and resilience.3 Strategic interaction: endogenous link formation, efficiency vs
stability, welfare issues4 Political economy: endogenous influence over rules of the
game: Meta-game and power
RemarksResilience analysis in absence of amplifications (level 2-3)can be misleading.
Results on connectedness tend to be opposite
Welfare analysis at level 3 maybe misleading. Level 4required.
Are the welfare measures appropriate and encompassing effectsto real economy?Is market power and regulatory capture taken into account?
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Financial Networks: Levels of Analysis
1 Static level, descriptive topology, across countries and legalsettings
2 Simplified agent behaviour: response to shocks and resilience.3 Strategic interaction: endogenous link formation, efficiency vs
stability, welfare issues4 Political economy: endogenous influence over rules of the
game: Meta-game and power
RemarksResilience analysis in absence of amplifications (level 2-3)can be misleading.
Results on connectedness tend to be opposite
Welfare analysis at level 3 maybe misleading. Level 4required.
Are the welfare measures appropriate and encompassing effectsto real economy?Is market power and regulatory capture taken into account?
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Financial Networks: Levels of Analysis
1 Static level, descriptive topology, across countries and legalsettings
2 Simplified agent behaviour: response to shocks and resilience.3 Strategic interaction: endogenous link formation, efficiency vs
stability, welfare issues4 Political economy: endogenous influence over rules of the
game: Meta-game and power
RemarksResilience analysis in absence of amplifications (level 2-3)can be misleading.
Results on connectedness tend to be opposite
Welfare analysis at level 3 maybe misleading. Level 4required.
Are the welfare measures appropriate and encompassing effectsto real economy?Is market power and regulatory capture taken into account?
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 1: Network density. In the literature
Policy discourse
Before the crisis: linkages and diversificationWidely-held view diversification is always good.
After the crisis: linkages and contagion
Optimal diversification is interior:
Various mechanisms: amplifications, bank runs, fire-sales,systemic risk costs: Brock et al. (2009); Ibragimov et al.(2011); Ibragimov and Walden (2007); Stiglitz (2010);Wagner (2009). Battiston ea. 2012 Liaisons; Tasca andBattiston 2012; 2013; Battiston ea. 2012 Default; Roukny ea.2013.
Optimal diversification is maximal:
Portofolio context: Markowitz (1952), Tobin (1958) andSamuelson (1967). Network, with no amplifications: Allenand Gale 2000; Eisenberg and Noe; Gai and Kapadia 2010;Golub ea. 2013; Acemoglu 2013.
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
What Optimal Network Architecture?
1 Topology
2 Tier-1 capital vs degree (no. of contracts)
3 Asset market liquidity and bank liquidity
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Limitations of Default Cascades Models
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Limitations of Default Cascades Models
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Limitations of Default Cascades Models
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Limitations of Default Cascades Models
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Run of Short Term Lenders
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Run of Short Term Lenders
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Run of Short Term Lenders
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Insight 3: Interconnectedness in stress-tests
Stress tests based on cascades:
With no amplification
cascades almost never occurhigh enough diversification: no cascades at all. Recipe: fulldiversification is best.
When additional externalities at work: e.g. fire-sales, creditruns, market procyclicality, illiquidity
cascades do occur (including bank-asset network sheds light)diversification has non-monotonic effectthere is no single topology that is just superiorthe most robust architecture depends on: market liquidity,types of shocks, correlations btw capital buffer and degree
Introduction Network Insights Surveillance Open issues
Issues on Systemic Risk Measures
VAR and ES are likely to be heavily underestimated
VAR and ES do not account interdependence. No analyticalsolution. Numerical work.VAR of a bank in isolation differs from VAR of a bank in anetworksystemic VAR of a network of interconnected banks from VARof aggregated system
Risk measures are blind1 to asset overvaluation2 network effects3 procyclical effects
risk: the whole exercise might give new but false sense ofsecurity
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
Introduction Network Insights Surveillance Open issues
References - 1
Anand, K., Gai, P., Kapadia, S., Brennan, S. and Willison, M. A network modelof financial system resilience. J. Econ. Behav. Organ. 85, 219–235 (2013).
Battiston, S., Puliga, M., Kaushik, R., Tasca, P. and Caldarelli, G. DebtRank:Too Central to Fail? Financial Networks, the FED and Systemic Risk. Sci. Rep.2, (2012).
Battiston, S., Gatti, D. D., Gallegati, M., Greenwald, B. C. N. and Stiglitz, J. E.Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk.J. Econ. Dyn. Control 36, 1121–1141 (2012).
Cifuentes, R., Ferrucci, G. and Shin, H. S. Liquidity risk and contagion. J. Eur.Econ. Assoc. 3, 556–566 (2005).
Eisenberg, L. and Noe, T. H. Systemic Risk in Financial Systems. Manage. Sci.47, 236–249 (2001).
Elsinger, H., Lehar, A. and Summer, M. Risk Assessment for Banking Systems.Manage. Sci. 52, 1301–1314 (2006).
Gai, P. and Kapadia, S. Contagion in financial networks. Proc. R. Soc. A Math.Phys. Eng. Sci. 466, 2401–2423 (2010).
Gai, P., Haldane, A., Kapadia, S. Complexity, concentration and contagion. J.Monet. Econ. 58, 453–470 (2011).
Haldane, A. G. Rethinking Financial Networks. Speech Financial Student Assoc.Amsterdam (2009).
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues
References - 2
Haldane, A. G. Rethinking Financial Networks. Speech Financial Student Assoc.Amsterdam (2009).
Hommes C., van der Leij M., in’t Veld D., Formation of a core-peripherynetwork in OTC markets
Kubler, F. , Schmedders, K. Stationary Equilibria in Asset-Pricing Models withIncomplete Markets and Collateral. Econometrica 71, 1767–1793 (2003).
Roukny, T., Bersini, H., Pirotte, H., Caldarelli, G., Battiston, S. DefaultCascades in Complex Networks: Topology and Systemic Risk. Sci. Rep. 3,(2013).
Tasca, P., Battiston, S. Market Procyclicality and Systemic Risk. Submitt.earlier version ETH Risk Cent. Work. Pap. Ser. ETH-RC-12-012 (2012).
Tasca, P., Battiston, S. Diversification and Financial Stability. Submitt. earlierversion ETH Risk Cent. Work. Pap. Ser. ETH-RC-12-013 (2012).
Stefano Battiston Measuring systemic risk in financial networks: Progress and challenges
Introduction Network Insights Surveillance Open issues