This volume presents a unified mathematical framework for the transmission channels for damaging shocks that can lead to instability in financial systems. As the title suggests, financial contagion is analogous to the spread of disease, and damaging financial crises may be better understood by bringing to bear ideas from studying other complex systems in our world. After considering how people have viewed financial crises and systemic risk in the past, it delves into the mechanics of the interactions between banking counterparties. It finds a common mathematical structure for types of crises that proceed through cascade mappings that approach a cascade equilibrium. Later chapters follow this theme, starting from the underlying random skeleton graph, developing into the theory of bootstrap percolation, ultimately leading to techniques that can determine the large scale nature of contagious financial cascades.
This volume presents a unified mathematical framework for the transmission channels for damaging shocks that can lead to instability in financial systems. As the title suggests, financial contagion is analogous to the spread of disease, and damaging financial crises may be better understood by bringing to bear ideas from studying other complex systems in our world. After considering how people have viewed financial crises and systemic risk in the past, it delves into the mechanics of the interactions between banking counterparties. It finds a common mathematical structure for types of crises that proceed through cascade mappings that approach a cascade equilibrium. Later chapters follow this theme, starting from the underlying random skeleton graph, developing into the theory of bootstrap percolation, ultimately leading to techniques that can determine the large scale nature of contagious financial cascades.
The Handbook on Systemic Risk, written by experts in the field, provides researchers with an introduction to the multifaceted aspects of systemic risks facing the global financial markets. The Handbook explores the multidisciplinary approaches to analyzing this risk, the data requirements for further research, and the recommendations being made to avert financial crisis. The Handbook is designed to encourage new researchers to investigate a topic with immense societal implications as well as to provide, for those already actively involved within their own academic discipline, an introduction to the research being undertaken in other disciplines. Each chapter in the Handbook will provide researchers with a superior introduction to the field and with references to more advanced research articles. It is the hope of the editors that this Handbook will stimulate greater interdisciplinary academic research on the critically important topic of systemic risk in the global financial markets.
The recent financial crisis and the difficulty of using mainstream macroeconomic models to accurately monitor and assess systemic risk have stimulated new analyses of how we measure economic activity and the development of more sophisticated models in which the financial sector plays a greater role. Markus Brunnermeier and Arvind Krishnamurthy have assembled contributions from leading academic researchers, central bankers, and other financial-market experts to explore the possibilities for advancing macroeconomic modeling in order to achieve more accurate economic measurement. Essays in this volume focus on the development of models capable of highlighting the vulnerabilities that leave the economy susceptible to adverse feedback loops and liquidity spirals. While these types of vulnerabilities have often been identified, they have not been consistently measured. In a financial world of increasing complexity and uncertainty, this volume is an invaluable resource for policymakers working to improve current measurement systems and for academics concerned with conceptualizing effective measurement.
The recent crisis has highlighted the crucial role that existing linkages among banks and financial institutions plays in channeling and amplifying shocks hitting the system. The structure and evolution of such web of linkages can be fruitfully characterized using concepts borrowed from the theory of (complex) networks. This paper critically surveys recent theoretical work that exploits this concept to explain the sources of contagion and systemic risk in financial markets. We taxonomize existing contributions according to the impact of network connectivity, bank heterogeneity, existing uncertainty in financial markets, portfolio composition of the banks. We end with a discussion of the most important challenges faced by theoretical network-based models of systemic risk. These include a better understanding of the causal links between network structure and the likelihood of systemic risk and increasingly using the empirical knowledge about real-world financial-network structures to calibrate theoretical models.
This paper presents a novel approach to investigate and model the network of euro area banks’ large exposures within the global banking system. Drawing on a unique dataset, the paper documents the degree of interconnectedness and systemic risk of the euro area banking system based on bilateral linkages. We develop a Contagion Mapping model fully calibrated with bank-level data to study the contagion potential of an exogenous shock via credit and funding risks. We find that tipping points shifting the euro area banking system from a less vulnerable state to a highly vulnerable state are a non-linear function of the combination of network structures and bank-specific characteristics.
The Financial Crisis Inquiry Report, published by the U.S. Government and the Financial Crisis Inquiry Commission in early 2011, is the official government report on the United States financial collapse and the review of major financial institutions that bankrupted and failed, or would have without help from the government. The commission and the report were implemented after Congress passed an act in 2009 to review and prevent fraudulent activity. The report details, among other things, the periods before, during, and after the crisis, what led up to it, and analyses of subprime mortgage lending, credit expansion and banking policies, the collapse of companies like Fannie Mae and Freddie Mac, and the federal bailouts of Lehman and AIG. It also discusses the aftermath of the fallout and our current state. This report should be of interest to anyone concerned about the financial situation in the U.S. and around the world.THE FINANCIAL CRISIS INQUIRY COMMISSION is an independent, bi-partisan, government-appointed panel of 10 people that was created to "examine the causes, domestic and global, of the current financial and economic crisis in the United States." It was established as part of the Fraud Enforcement and Recovery Act of 2009. The commission consisted of private citizens with expertise in economics and finance, banking, housing, market regulation, and consumer protection. They examined and reported on "the collapse of major financial institutions that failed or would have failed if not for exceptional assistance from the government."News Dissector DANNY SCHECHTER is a journalist, blogger and filmmaker. He has been reporting on economic crises since the 1980's when he was with ABC News. His film In Debt We Trust warned of the economic meltdown in 2006. He has since written three books on the subject including Plunder: Investigating Our Economic Calamity (Cosimo Books, 2008), and The Crime Of Our Time: Why Wall Street Is Not Too Big to Jail (Disinfo Books, 2011), a companion to his latest film Plunder The Crime Of Our Time. He can be reached online at www.newsdissector.com.
Therefore, a simple labeling via default probability or expected loss does not discriminate sufficiently their downgrade risk. We propose to supplement ratings with indicators of downgrade risk. To overcome some of the drawbacks of existing rating methods, we suggest a risk-based rating procedure for structured products. Finally, we formulate a series of recommendations regarding the use of credit ratings for CDOs and other structured credit instruments.
Financial network analysis is used to provide firm level bottom-up holistic visualizations of interconnections of financial obligations in global OTC derivatives markets. This helps to identify Systemically Important Financial Intermediaries (SIFIs), analyse the nature of contagion propagation, and also monitor and design ways of increasing robustness in the network. Based on 2009 FDIC and individually collected firm level data covering gross notional, gross positive (negative) fair value and the netted derivatives assets and liabilities for 202 financial firms which includes 20 SIFIs, the bilateral flows are empirically calibrated to reflect data-based constraints. This produces a tiered network with a distinct highly clustered central core of 12 SIFIs that account for 78 percent of all bilateral exposures and a large number of financial intermediaries (FIs) on the periphery. The topology of the network results in the “Too- Interconnected-To-Fail” (TITF) phenomenon in that the failure of any member of the central tier will bring down other members with the contagion coming to an abrupt end when the ‘super-spreaders’ have demised. As these SIFIs account for the bulk of capital in the system, ipso facto no bank among the top tier can be allowed to fail, highlighting the untenable implicit socialized guarantees needed for these markets to operate at their current levels. Systemic risk costs of highly connected SIFIs nodes are not priced into their holding of capital or collateral. An eigenvector centrality based ‘super-spreader’ tax has been designed and tested for its capacity to reduce the potential socialized losses from failure of SIFIs.
