Portfolio Compression: Positive and Negative Effects on Systemic Risk

10 Pages Posted: 8 Mar 2018 Last revised: 11 Jun 2018

See all articles by Steffen Schuldenzucker

Steffen Schuldenzucker

University of Zurich - Department of Informatics

Sven Seuken

University of Zurich - Department of Informatics

Stefano Battiston

University of Zurich - Department of Banking and Finance; Swiss Finance Institute

Date Written: June 2, 2018

Abstract

We show how conservative portfolio compression, i.e., netting cycles in a financial network, can increase systemic risk even though the exposures of all banks to each other decrease. We provide a simple example where for a certain network structure and shocks to banks, portfolio compression is socially detrimental, but individually preferred by all banks that participate in the compression. We then show via simulations that whether or not portfolio compression is socially desirable depends on the intensity of a shock: compression can make a financial system more resilient to small shocks, but more vulnerable to large shocks.

Keywords: Financial Networks, Systemic Risk, Portfolio Compression

JEL Classification: C62, G01, G12

Suggested Citation

Schuldenzucker, Steffen and Seuken, Sven and Battiston, Stefano, Portfolio Compression: Positive and Negative Effects on Systemic Risk (June 2, 2018). Available at SSRN: https://ssrn.com/abstract=3135960 or http://dx.doi.org/10.2139/ssrn.3135960

Steffen Schuldenzucker (Contact Author)

University of Zurich - Department of Informatics ( email )

Binzmühlestrasse 14
Zürich, CH-8050
Switzerland

HOME PAGE: http://www.ifi.uzh.ch/en/ce/people/schuldenzucker.html

Sven Seuken

University of Zurich - Department of Informatics ( email )

Binzmühlestrasse 14
Zürich, CH-8050
Switzerland

HOME PAGE: http://www.ifi.uzh.ch/en/ce/people/seuken.html

Stefano Battiston

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

Andreasstrasse 15
Zürich, 8050
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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