Optimal Network Compression
33 Pages Posted: 8 Oct 2020 Last revised: 8 Feb 2021
Date Written: August 20, 2020
This paper introduces a formulation of the optimal network compression problem for financial systems. This general formulation is presented for different levels of network compression or rerouting allowed from the initial inter-bank network. We prove that this problem is, generically, NP-hard. We focus on objective functions generated by systemic risk measures under systematic shocks to the financial network. We conclude by studying the optimal compression problem for specific networks; this permits us to study the so-called robust fragility of certain network topologies more generally as well as the potential benefits and costs of network compression.
Keywords: systemic risk, financial networks, portfolio compression, genetic algorithm
JEL Classification: D85, G01, G28
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