What is the Minimal Systemic Risk in Financial Exposure Networks?

INET Oxford Working Paper

25 Pages Posted: 6 Jun 2019

See all articles by Christian Diem

Christian Diem

Complexity Science Hub Vienna; Vienna University of Economics and Business

Anton Pichler

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School; University of Oxford - Mathematical Institute; Complexity Science Hub Vienna

Stefan Thurner

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

Date Written: May 10, 2019

Abstract

Management of systemic risk in financial markets is traditionally associated with setting (higher) capital requirements for market participants. There are indications that while equity ratios have been increased massively since the financial crisis, systemic risk levels might not have lowered, but even increased (see ECB data; SRISK time series). It has been shown that systemic risk is to a large extent related to the underlying network topology of financial exposures. A natural question arising is how much systemic risk can be eliminated by optimally rearranging these networks and without increasing capital requirements. Overlapping portfolios with minimized systemic risk which provide the same market functionality as empirical ones have been studied by Pichler et al (2018). Here we propose a similar method for direct exposure networks, and apply it to cross-sectional interbank loan networks, consisting of 10 quarterly observations of the Austrian interbank market. We show that the suggested framework rearranges the network topology, such that systemic risk is reduced by a factor of approximately 3.5, and leaves the relevant economic features of the optimized network and its agents unchanged. The presented optimization procedure is not intended to actually re-configure interbank markets, but to demonstrate the huge potential for systemic risk management through rearranging exposure networks, in contrast to increasing capital requirements that were shown to have only marginal effects on systemic risk Poledna et al. (2017). Ways to actually incentivize a self-organized formation toward optimal network configurations were introduced in Thurner and Poledna (2013) and Poledna and Thurner (2016). For regulatory policies concerning financial market stability the knowledge of minimal systemic risk for a given economic environment can serve as a benchmark for monitoring actual systemic risk in markets.

Keywords: systemic risk-efficiency, interbank market, financial networks, contagion, network optimization, mixed-integer linear programming, DebtRank

Suggested Citation

Diem, Christian and Diem, Christian and Pichler, Anton and Thurner, Stefan, What is the Minimal Systemic Risk in Financial Exposure Networks? (May 10, 2019). INET Oxford Working Paper, Available at SSRN: https://ssrn.com/abstract=3391119 or http://dx.doi.org/10.2139/ssrn.3391119

Christian Diem (Contact Author)

Complexity Science Hub Vienna ( email )

Josefstädter Straße 39
Vienna
Austria

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Anton Pichler

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School ( email )

Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

HOME PAGE: http://www.anton-pichler.com

University of Oxford - Mathematical Institute ( email )

Andrew Wiles Building
Radcliffe Observatory Quarter (550)
Oxford, OX2 6GG
United Kingdom

Complexity Science Hub Vienna ( email )

Josefstädter Straße 39
Vienna
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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