Stress Testing the Resilience of Financial Networks

19 Pages Posted: 25 Dec 2010 Last revised: 28 Dec 2010

See all articles by Hamed Amini

Hamed Amini

Ecole Polytechnique Fédérale de Lausanne

Rama Cont

University of Oxford; CNRS

Andreea Minca

Cornell University

Date Written: September 24, 2010

Abstract

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.

Keywords: systemic risk, banking network, stress test, counterparty risk, macro-prudential regulation, complex network, scale-free network

JEL Classification: G18, G21, G28

Suggested Citation

Amini, Hamed and Cont, Rama and Minca, Andreea, Stress Testing the Resilience of Financial Networks (September 24, 2010). Available at SSRN: https://ssrn.com/abstract=1730732 or http://dx.doi.org/10.2139/ssrn.1730732

Hamed Amini

Ecole Polytechnique Fédérale de Lausanne ( email )

Station 5
Odyssea 1.04
1015 Lausanne, CH-1015
Switzerland

Rama Cont (Contact Author)

University of Oxford ( email )

Mathematical Institute
Oxford, OX2 6GG
United Kingdom

HOME PAGE: http://https://www.maths.ox.ac.uk/people/rama.cont

CNRS ( email )

LPSM
Sorbonne University
Paris
France

HOME PAGE: http://rama.cont.perso.math.cnrs.fr/

Andreea Minca

Cornell University ( email )

222 Rhodes Hall
Ithaca, NY NY 14853
United States

HOME PAGE: http://people.orie.cornell.edu/acm299/

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