Liability Concentration and Systemic Losses in Financial Networks

Operations Research, Forthcoming

33 Pages Posted: 5 Jun 2016

See all articles by Agostino Capponi

Agostino Capponi

Columbia University

Peng-Chu Chen

The University of Hong Kong

David Yao

Columbia University

Date Written: May 29, 2015

Abstract

The objective of this study is to develop a majorization-based tool to compare financial networks with a focus on the implications of liability concentration. Specifically, we quantify liability concentration by applying the majorization order to the liability matrix that captures the interconnectedness of banks in a financial network. We develop notions of balancing and unbalancing networks to bring out the qualitatively different implications of liability concentration on the system's loss profile. We illustrate how to identify networks that are balancing or unbalancing, and make connections to interbank structures identified by empirical research, such as perfect and imperfect tiering schemes. An empirical analysis of the network formed by eight representative European countries' banking sectors suggests that the system is either unbalancing or close to it, persistently over time. This empirical finding, along with the majorization results, supports regulatory policies aiming at limiting the size of gross exposures to individual counter parties.

Keywords: systemic risk, financial network, interbank liabilities, majorization

JEL Classification: C63, G21, G33, G13

Suggested Citation

Capponi, Agostino and Chen, Peng-Chu and Yao, David, Liability Concentration and Systemic Losses in Financial Networks (May 29, 2015). Operations Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2789311

Agostino Capponi

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Peng-Chu Chen (Contact Author)

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

David Yao

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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