A fix for failure that’s contagious

Applying ideas from diversification and cascading failures to mitigate the propagation of risk across inter-connected institutions.

Financial networks are like sprawling extended families. Their components are all interconnected, but they aren’t obviously dependent on each other until something goes wrong. Distress or failure in one area can propagate through the network via the very same avenues that made it seemingly strong and diverse.

This project captures the intricacies of financial systems using complex networks. By modelling the channels through which risk and stress in the network is communicated, it is possible to predict how different reactions to shocks will affect the network as a whole. Focusing on the microscopic theory of these networks, the DebtRank algorithm is studied as a tool for predicting the likelihood of systemic failure in a network, and appropriate immunisation strategies for limiting the spread of distress are proposed.

The sentiment of borrowers and lenders in a financial network is what drives markets to success, but also to ruin. Zooming in on the non-linear links between these players quantifies the likely reactions to key events, and predicts how distress will spread. Modelling these weaknesses will enable strategies to limit system-wide catastrophic failure to be tuned, and ultimately prevent future financial crashes.

A fix for failure that’s contagious

Related papers

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    Journal of Computational Social Science

    Modelling financial systemic risk

    Complex networks model the links between financial institutions and how these channels can transition from diversifying to propagating risk.

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    PLoS ONE

    Non-linear distress propagation

    Non-linear models of distress propagation in financial networks characterise key regimes where shocks are either amplified or suppressed.

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    Journal de Physique IV

    Immunisation of systemic risk

    Targeted immunisation policies limit distress propagation and prevent system-wide crises in financial networks according to sandpile models.

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    Proceedings of the National Academy of Sciences of the USA

    The price of complexity

    Increasing the complexity of the network of contracts between financial institutions decreases the accuracy of estimating systemic risk.

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    Physica D Nonlinear Phenomena

    Cascades in flow networks

    Coupled distribution grids are more vulnerable to a cascading systemic failure but they have larger safe regions within their networks.

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    DebtRank and shock propagation

    A dynamical microscopic theory of instability for financial networks reformulates the DebtRank algorithm in terms of basic accounting principles.

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    Scientific Reports

    Default cascades in networks

    The optimal architecture of a financial system is only dependent on its topology when the market is illiquid, and no topology is always superior.

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    Journal of Statistical Physics

    Bootstrapping topology and risk

    Information about 10% of the links in a complex network is sufficient to reconstruct its main features and resilience with the fitness model.