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The Price of Complexity in Financial Networks

28 Pages Posted: 15 Apr 2015 Last revised: 2 Nov 2015

Stefano Battiston

University of Zurich - Department of Banking and Finance

Guido Caldarelli

IMT Alti Studi Lucca

Robert May

University of Oxford

Tarik Roukny

Massachusetts Institute of Technology (MIT)

Joseph E. Stiglitz

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: November 2015

Abstract

Financial institutions form multi-layer networks of contracts among each other and exposures to common assets. As a result, the default probability of one institution depends on the default probability of all the other institutions in the network. Here, we show how small errors on the knowledge of the network of contracts can lead to large errors on the probability of systemic defaults. From the point of view of financial regulators, our findings show that the complexity of financial instruments and the complexity of networks of contracts may decrease our ability to estimate and mitigate systemic risk.

Keywords: financial markets, systemic risk, complex systems, computational social science

JEL Classification: D85, L14, E50

Suggested Citation

Battiston, Stefano and Caldarelli, Guido and May, Robert and Roukny, Tarik and Stiglitz, Joseph E., The Price of Complexity in Financial Networks (November 2015). Columbia Business School Research Paper No. 15-49. Available at SSRN: https://ssrn.com/abstract=2594028 or http://dx.doi.org/10.2139/ssrn.2594028

Stefano Battiston (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Andreasstrasse 15
Zürich, 8050
Switzerland

Guido Caldarelli

IMT Alti Studi Lucca ( email )

Piazza San Francesco 19
Lucca, 55100
Italy

Robert May

University of Oxford ( email )

Department of Economics
Manor Road
Oxford, OX1 3UQ
United Kingdom

Tarik Roukny

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

3022 Broadway
814 Uris Hall
New York, NY 10027
United States
(212) 854-0671 (Phone)
(212) 662-8474 (Fax)

HOME PAGE: http://www.josephstiglitz.com

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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