Networks in Finance

Wharton Financial Institutions Center Working Paper No. 08-07

20 Pages Posted: 19 Feb 2008 Last revised: 4 Dec 2011

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Ana Babus

Federal Reserve Bank of Chicago; Imperial College London

Date Written: August 2008

Abstract

Modern financial systems exhibit a high degree of interdependence. There are different possible sources of connections between financial institutions, stemming from both the asset and the liability side of their balance sheet. For instance, banks are directly connected through mutual exposures acquired on the interbank market. Likewise, holding similar portfolios or sharing the same mass of depositors creates indirect linkages between financial institutions. Broadly understood as a collection of nodes and links between nodes, networks can be a useful representation of financial systems. By providing means to model the specifics of economic interactions, network analysis can better explain certain economic phenomena. In this paper we argue that the use of network theories can enrich our understanding of financial systems. We review the recent developments in financial networks, highlighting the synergies created from applying network theory to answer financial questions. Further, we propose several directions of research. First, we consider the issue of systemic risk. In this context, two questions arise: how resilient financial networks are to contagion, and how financial institutions form connections when exposed to the risk of contagion. The second issue we consider is how network theory can be used to explain freezes in the interbank market of the type we have observed in August 2007 and subsequently. The third issue is how social networks can improve investment decisions and corporate governance. Recent empirical work has provided some interesting results in this regard. The fourth issue concerns the role of networks in distributing primary issues of securities as, for example, in initial public offerings, or seasoned debt and equity issues. Finally, we consider the role of networks as a form of mutual monitoring as in microfinance.

Suggested Citation

Allen, Franklin and Babus, Ana, Networks in Finance (August 2008). Wharton Financial Institutions Center Working Paper No. 08-07. Available at SSRN: https://ssrn.com/abstract=1094883 or http://dx.doi.org/10.2139/ssrn.1094883

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Ana Babus

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

HOME PAGE: http://www.anababus.net

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