Andreea Minca

Resilience to Contagion in Financial Networks

We derive rigorous asymptotic results for the magnitude of contagion in a large counterparty network and give an analytical expression for the asymptotic fraction of defaults, in terms of network characteristics. Our results extend previous studies on contagion in random graphs to inhomogeneous-directed graphs with a given degree sequence and arbitrary distribution of weights. We introduce a criterion for the resilience of a large financial network to the insolvency of a small group of financial institutions and quantify how contagion amplifies small shocks to the network. Our results emphasize the role played by “contagious links” and show that institutions which contribute most to network instability have both large connectivity and a large fraction of contagious links. The asymptotic results show good agreement with simulations for networks with realistic sizes.

STRESS TESTING THE RESILIENCE OF FINANCIAL NETWORKS

We propose a simulation-free framework for stress testing the resilience of a financial network to external shocks affecting balance sheets. Whereas previous studies of contagion effects in financial networks have relied on large scale simulations, our approach uses a simple analytical criterion for resilience to contagion, based on an asymptotic analysis of default cascades in heterogeneous networks. In particular, our methodology does not require to observe the whole network but focuses on the characteristics of the network which contribute to its resilience. Applying this framework to a sample network, we observe that the size of the default cascade generated by a macroeconomic shock across balance sheets may exhibit a sharp transition when the magnitude of the shock reaches a certain threshold: Beyond this threshold, contagion spreads to a large fraction of the financial system. An upper bound is given for the threshold in terms of the characteristics of the network.

Stress Testing the Resilience of Financial Networks

We propose a framework for stress testing the resilience of a financial network to external shocks affecting balance sheets. Whereas previous studies of contagion effects in financial networks have relied on large scale simulations, our approach uses a simple analytical criterion for resilience to contagion, based on an asymptotic analysis of default cascades in heterogeneous networks. In particular, our methodology does not require to observe the whole network but focuses on the characteristics of the network which contribute to its resilience. Applying this framework to a sample network, we observe that the size of the default cascade generated by a macroeconomic shock across balance sheets may exhibit a sharp transition when the magnitude of the shock reaches a certain threshold: beyond this threshold, contagion spreads to a large fraction of the financial system. An upper bound is given for the threshold in terms of the characteristics of the network.

Credit Default Swaps and Systemic Risk

We present a network model for investigating the impact on systemic risk of central clearing of over the counter (OTC) credit default swaps (CDS). We model contingent cash flows resulting from CDS and other OTC derivatives by a multi-layered network with a core-periphery structure, which is flexible enough to reproduce the gross and net exposures as well as the heterogeneity of market shares of participating institutions. We analyze illiquidity cascades resulting from liquidity shocks and show that the contagion of illiquidity takes place along a sub-network constituted by links identified as ’critical receivables’. A key role is played by the long intermediation chains inherent to the structure of the OTC network, which may turn into chains of critical receivables. We calibrate our model to data representing net and gross OTC exposures of large dealer banks and use this model to investigate the impact of central clearing on network stability. We find that, when interest rate swaps are cleared, central clearing of credit default swaps through a well-capitalized CCP can reduce the probability and the magnitude of a systemic illiquidity spiral by reducing the length of the chains of critical receivables within the financial network. These benefits are reduced, however, if some large intermediaries are not included as clearing members.

Networks of Common Asset Holdings: Aggregation and Measures of Vulnerability

This paper quantifies the interrelations induced by common asset holdings among financial institutions. A network representation emerges, where nodes represent portfolios and edge weights aggregate the common asset holdings and the liquidity of these holdings. As a building block, we introduce a simple model of order imbalance that estimates price impacts due to liquidity shocks. In our model, asset prices are set by a competitive risk-neutral market maker and the arrival rates for the buyers and sellers depend on the common asset holdings. We illustrate the relevance of our aggregation method and the resulting network representation using data on mutual fund asset holdings. We introduce three related measures of vulnerability in the network and demonstrate a strong dependence between mutual fund returns and these measures.

Uniqueness of Equilibrium in a Payment System with Liquidation Costs

We study a financial network where forced liquidations of an illiquid asset have a negative impact on its price, thus reinforcing network contagion. We give conditions for uniqueness of the clearing asset price and liability payments. Our main result holds under mild and natural assumptions on the price impact function: monotonicity of the price impact function and strict monotonicity of the proceeds of liquidation in the liquidated quantity.

Mathematical Modeling of Systemic Risk

Since the onset of the financial crisis in 2007, more than 370 of the almost 8,000 US banks insured by the Federal Deposit Insurance Corporation have failed. By comparison, between 2000 and 2004 there were around 30 failures and no failures occurred between 2005 and the beginning of 2007.

The Topology of Overlapping Portfolio Networks

This paper analyzes the topology of the network of common asset holdings, where nodes represent managed portfolios and edge weights capture the impact of liquidations. Asset holdings data is extracted from the 13F filings. We consider the degree centrality as the degree in the subnetwork of weak links, where weak links are those that lead to significant liquidations. We explore the applications of this network representation to clustering and forecasting. To validate the weight attribution and the threshold used to define the weak links, we show that the degree centrality is correlated with excess returns, and is significant after we control for the Carhart four factors. The network of weak links has a scale free structure, similar to financial networks of balance sheet exposures. Moreover, a small number of clusters, densely linked, concentrate a significant proportion of the portfolios.

Inhomogeneous Financial Networks and Contagious Links

We propose a framework for testing the possibility of large cascades in financial networks. This framework accommodates a variety of specifications for the probabilities of emergence of “contagious links” conditional on a macroeconomic shock, where a contagious link leads to the default of a bank following the default of its counterparty. Under general contagion mechanisms and incomplete information, the financial network is modeled as an inhomogeneous random graph, where the conditional probabilities of having contagious links depend on banks’ characteristics. We give different bounds on the size of the cascade through contagious links and derive testable conditions for this cascade to be small.

When Do Creditors with Heterogeneous Beliefs Agree to Run

This paper explores, in a multiperiod setting, the funding liquidity of a borrower that finances its operations through short-term debt. The short-term debt is provided by a continuum of creditors with heterogeneous beliefs about the prospects of the borrower. In each period, creditors observe the borrower’s fundamentals and decide on the amount they invest in its short-term debt. We formalize this problem as a coordination game, and we show that there exists a unique reasonable Nash equilibrium. We show that the borrower is able to refinance if and only if the liquid net worth is above an illiquidity barrier, and we explicitly find this barrier in terms of the distribution of capital and beliefs across creditors. Copyright Springer-Verlag Berlin Heidelberg 2015