By Amanah Ramadiah, Domenico Di Gangi, D. Ruggiero Lo Sardo, Valentina Macchiati, Tuan Pham Minh, Francesco Pinotti, Mateusz Wilinski, Paolo Barucca and Giulio Cimini.
The paper, ‘Network Sensitivity of Systemic Risk’, explores how propagation dynamics depend on the topological details of an underlying network. It provides detailed understanding of the interplay between systemic risk measures and network structures, which provides central banks and regulators with new insights into how to reliably improve the structure of the financial system and reduce systemic risk.
FNA’s Amanah Ramadiah and fellow researchers first consider various network topologies consistent with the balance sheets taken from financial institution data.
The research then introduces a robust network sensitivity methodology to explore a range of weighted financial networks with varying densities. These variations cover sparse low-density networks to complete ones and apply two paramount models of both default contagion and distress contagion. Using this method, the team could then understand the differences in relative losses that different network structures, shocks and contagion mechanics can produce.
By studying the different structures of the interbank network, Ramadiah et al. show how each impacts systemic risk. The research confirms that the systemic risk properties of a financial network are susceptible to its network features and demonstrates the complexity of the interbank system, noting that many variables determine a network’s resilience.
The research also explores the block structure of the network to find that an assortative modular design works well to represent the market of several countries where home and foreign connectivity differ. However, financial networks usually take on a disassortative modular case. In both cases, the paper demonstrates how a shock from one block propagates to the other but does not reveal further discontinuity. The research suggests moving away from the pure bipartite case can slowly decrease systemic risk.
Overall, Ramadiah et al. conclude that the outcome of a systemic event depends on the details of both the underlying network and the shock propagation. The findings presented in the paper pave the way for more in-depth analysis and may help develop regulatory policies to improve the robustness of financial markets.
Read the full paper here >