Portfolio Compression in Financial Networks: Incentives and Systemic Risk

50 Pages Posted: 8 Mar 2018 Last revised: 13 Sep 2021

See all articles by Steffen Schuldenzucker

Steffen Schuldenzucker

Goethe University Frankfurt

Sven Seuken

University of Zurich - Department of Informatics

Date Written: September 11, 2021

Abstract

We study portfolio compression, a procedure that removes cycles of liabilities in a financial network. We analyze the effect of compression on social welfare and the banks’ incentives to accept a compression proposal. Regarding social welfare, we show that, contrary to conventional wisdom, compression may be detrimental and banks’ incentives may be misaligned with social welfare. We then derive sufficient conditions that guarantee that compression leads to a Pareto improvement for all banks. Regarding incentives, it is known that compression may be detrimental for an involved bank. We analyze which network structures give rise to this effect and derive sufficient conditions such that the involved banks are never worse off when accepting a compression. Our results contribute to a better understanding of the implications of recent regulatory policy.

Keywords: Portfolio Compression, Financial Networks, Systemic Risk

JEL Classification: D85, G01, G28

Suggested Citation

Schuldenzucker, Steffen and Seuken, Sven, Portfolio Compression in Financial Networks: Incentives and Systemic Risk (September 11, 2021). 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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