Liability Concentration and Systemic Losses in Financial Networks

Agostino Capponi (), Peng-Chu Chen () and David D. Yao ()
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Agostino Capponi: Industrial Engineering and Operations Research Department, Columbia University, New York, New York 10027
Peng-Chu Chen: School of Industrial Engineering, Purdue University, West Lafayette, Indiana 47906
David D. Yao: Industrial Engineering and Operations Research Department, Columbia University, New York, New York 10027

Operations Research, 2016, vol. 64, issue 5, 1121-1134

Abstract: The objective of this study is to develop a majorization-based tool to compare financial networks with a focus on the implications of liability concentration. Specifically, we quantify liability concentration by applying the majorization order to the liability matrix that captures the interconnectedness of banks in a financial network. We develop notions of balancing and unbalancing networks to bring out the qualitatively different implications of liability concentration on the system’s loss profile. We illustrate how to identify networks that are balancing or unbalancing, and we make connections to interbank structures identified by empirical research, such as perfect and imperfect tiering schemes. An empirical analysis of the network formed by the banking sectors of eight representative European countries suggests that the system is either unbalancing or close to it, persistently over time. This empirical finding, along with the majorization results, supports regulatory policies aiming at limiting the size of gross exposures to individual counterparties.

Keywords: majorization; systemic risk; liability concentration; financial networks; financial contagion (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (24)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:oropre:v:64:y:2016:i:5:p:1121-1134

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