Systemic Risk Management in Financial Networks with Credit Default Swaps

21 Pages Posted: 11 Jan 2016 Last revised: 6 Nov 2020

See all articles by Mathieu V. Leduc

Mathieu V. Leduc

Paris School of Economics (PSE) / Université Paris 1

Sebastian Poledna

International Institute for Applied Systems Analysis (IIASA)

Stefan Thurner

Institute for Science of Complex Systems, Medical University of Vienna; Santa Fe Institute

Date Written: August 1, 2017

Abstract

We study insolvency cascades in an interbank system when banks are allowed to insure their loans with credit default swaps (CDS) sold by other banks. We show that, by properly shifting financial exposures from one institution to another, a CDS market can be designed to rewire the network of interbank exposures in a way that makes it more resilient to insolvency cascades. A regulator can use information about the topology of the interbank network to devise a systemic insurance surcharge that is added to the CDS spread. CDS contracts are thus effectively penalized according to how much they contribute to increasing systemic risk. CDS contracts that decrease systemic risk remain untaxed. We simulate this regulated CDS market using an agent-based model (CRISIS macro-financial model) and we demonstrate that it leads to an interbank system that is more resilient to insolvency cascades.

Keywords: Systemic Risk, Credit Default Swaps, DebtRank, Agent-Based Models, Multiplex Networks, Interbank Systems

JEL Classification: E58, G21, G28, G32, G33, G38

Suggested Citation

Leduc, Mathieu V. and Poledna, Sebastian and Thurner, Stefan, Systemic Risk Management in Financial Networks with Credit Default Swaps (August 1, 2017). Available at SSRN: https://ssrn.com/abstract=2713200 or http://dx.doi.org/10.2139/ssrn.2713200

Mathieu V. Leduc (Contact Author)

Paris School of Economics (PSE) / Université Paris 1 ( email )

48 boulevard Jourdan
Paris, 75014
France

HOME PAGE: http://sites.google.com/site/mattvleduc/

Sebastian Poledna

International Institute for Applied Systems Analysis (IIASA) ( email )

Schlossplatz 1
Laxenburg, A-2361
Austria

Stefan Thurner

Institute for Science of Complex Systems, Medical University of Vienna ( email )

Spitalgasse 23
Vienna, A-1090
Austria

Santa Fe Institute ( email )

1399 Hyde Park Road
Santa Fe, NM 87501
United States

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