Modeling Risk Sharing and Impact on Systemic Risk

Walter Farkas and Patrick Lucescu ()
Additional contact information
Walter Farkas: Department of Finance, University of Zurich, Plattenstrasse 14, 8032 Zurich, Switzerland
Patrick Lucescu: Department of Finance, University of Zurich, Plattenstrasse 14, 8032 Zurich, Switzerland

Mathematics, 2024, vol. 12, issue 13, 1-19

Abstract: This paper develops a simplified agent-based model to investigate the dynamics of risk transfer and its implications for systemic risk within financial networks, focusing specifically on credit default swaps (CDSs) as instruments of risk allocation among banks and firms. Unlike broader models that incorporate multiple types of economic agents, our approach explicitly targets the interactions between banks and firms across three markets: credit, interbank loans, and CDSs. This model diverges from the frameworks established by prior researchers by simplifying the agent structure, which allows for more focused calibration to empirical data—specifically, a sample of Swiss banks—and enhances interpretability for regulatory use. Our analysis centers around two control variables, C D S c and C D S n , which control the likelihood of institutions participating in covered and naked CDS transactions, respectively. This approach allows us to explore the network’s behavior under varying levels of interconnectedness and differing magnitudes of deposit shocks. Our results indicate that the network can withstand minor shocks, but higher levels of CDS engagement significantly increase variance and kurtosis in equity returns, signaling heightened instability. This effect is amplified during severe shocks, suggesting that CDSs, instead of mitigating risk, propagate systemic risk, particularly in highly interconnected networks. These findings underscore the need for regulatory oversight to manage risk concentration and ensure financial stability.

Keywords: systemic risk; agent-based modeling; financial networks; risk transfer; network interconnectedness; credit default swaps (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.mdpi.com/2227-7390/12/13/2083/pdf (application/pdf)
https://www.mdpi.com/2227-7390/12/13/2083/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jmathe:v:12:y:2024:i:13:p:2083-:d:1427851

Access Statistics for this article

Mathematics is currently edited by Ms. Emma He

More articles in Mathematics from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().