Measuring Systemic Risk and Contagion in Financial Networks
Friedrich-Alexander-Universität Erlangen-Nürnberg; Massachusetts Institute of Technology - Sloan School of Management
University of Aarhus; True North Institute
Massachusetts Institute of Technology (MIT)
February 26, 2011
Liabilities between financial entities form a network. The clearing of liabilities and thereby contagion of risk and default depend on this network structure. We provide an accurate and unrestricted mathematical model to understand clearing and propagated default in financial networks. This yields a precise measure for the systemic risk induced by individual financial entities. Moreover, the model allows to compute optimal bailout strategies that either minimize the cost of the intervention or maximize the stabilizing effect for a given bailout budget. Finally, the computational efficiency of the model allows to analyze very large scale networks quickly.
Number of Pages in PDF File: 20
Keywords: systemic risk, network flows, contagion, clearingworking papers series
Date posted: March 1, 2011
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