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Why do vulnerability cycles matter in financial networks?

Thiago Silva (), Benjamin Tabak () and Solange Guerra

Physica A: Statistical Mechanics and its Applications, 2017, vol. 471, issue C, 592-606

Abstract: We compare two widely employed models that estimate systemic risk: DebtRank and Differential DebtRank. We show that not only network cyclicality but also the average vulnerability of banks are essential concepts that contribute to widening the gap in the systemic risk estimates of both approaches. We find that systemic risk estimates are the same whenever the network has no cycles. However, in case the network presents cyclicality, then we need to inspect the average vulnerability of banks to estimate the underestimation gap. We find that the gap is small regardless of the cyclicality of the network when its average vulnerability is large. In contrast, the observed gap follows a quadratic behavior when the average vulnerability is small or intermediate. We show results using an econometric exercise and draw guidelines both on artificial and real-world financial networks.

Keywords: Networks; Systemic risk; DebtRank; Contagion; Financial markets (search for similar items in EconPapers)
Date: 2017
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Working Paper: Why Do Vulnerability Cycles Matter in Financial Networks? (2016) Downloads
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DOI: 10.1016/j.physa.2016.12.063

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