Systemic risk and financial networks

Bingqing Li and Xiaoyuan Zhang

The Quarterly Review of Economics and Finance, 2024, vol. 94, issue C, 25-36

Abstract: We develop a network-based probabilistic model to analyze systemic risk within a network of interconnected institutions. Harnessing the power of economic connections, we construct a weighted network that effectively captures the extent of direct risk spillovers. Then the risk contagion probabilistic model is constructed with the aid of the risk orbit contagion idea and inter-institutional dependencies. Our model examines contagion characteristics, uncertainty, and interdependence, revealing that neither a ring nor a complete financial network is optimal. We discover that the expected loss of the network does not have a monotonic relationship with the number of partners, depending on the trade-off between the network density and direct risk spillovers to mitigate systemic risk.

Keywords: Risk contagion; Network density; Optimal network; Risk orbits (search for similar items in EconPapers)
JEL-codes: G33 L14 M21 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:94:y:2024:i:c:p:25-36

DOI: 10.1016/j.qref.2023.12.012

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