Portfolio Compression in Financial Networks: Incentives and Systemic Risk

34 Pages Posted: 8 Mar 2018 Last revised: 2 Jun 2020

See all articles by Steffen Schuldenzucker

Steffen Schuldenzucker

Goethe University Frankfurt

Sven Seuken

University of Zurich - Department of Informatics

Date Written: June 1, 2020

Abstract

We study portfolio compression, a procedure that removes cycles of liabilities in a financial network. We analyze the incentives for banks to engage in compression and its systemic effects in terms of all banks' equities. We show that, contrary to conventional wisdom, portfolio compression may be socially and individually detrimental and banks' incentives may be misaligned with social welfare. We then present sufficient conditions under which banks involved in the compression have an incentive to agree to it or under which the compression is even a Pareto improvement for all banks. Our results contribute to a better understanding of the implications of recent regulatory policy.

Keywords: Portfolio Compression, Financial Networks, Systemic Risk

JEL Classification: C62, G01, G12

Suggested Citation

Schuldenzucker, Steffen and Seuken, Sven, Portfolio Compression in Financial Networks: Incentives and Systemic Risk (June 1, 2020). Available at SSRN: https://ssrn.com/abstract=3135960 or http://dx.doi.org/10.2139/ssrn.3135960

Steffen Schuldenzucker (Contact Author)

Goethe University Frankfurt ( email )

Robert-Mayer-Str. 11-15
Frankfurt am Main, 60325
Germany

HOME PAGE: http://algo.cs.uni-frankfurt.de/~sschuldenzucker/

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

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