Diversification and Systemic Risk of Networks Holding Common Assets

Yajing Huang () and Taoxiong Liu
Additional contact information
Yajing Huang: Beijing Forestry University

Computational Economics, 2023, vol. 61, issue 1, No 13, 388 pages

Abstract: Abstract This paper focuses on studying the influence of diversification on systemic risk for networks, which consist of a set of companies holding common assets. Diversification prevents initial company failures, but permits financial contagions due to companies’ overlapping asset portfolios. We comprehensively study diversification’s effect on systemic risk by proposing not only three different measurements of systemic risk, but also an algorithm to increase a Poisson-random network’s diversification in simulations. The numerical results show that whether risk is measured in terms of the number of failed companies or the total assets’ loss of value, diversification and systemic risk exhibit an inverted U-shaped relationship. The mechanism to generate such a relationship is further analyzed by combining the tradeoff effect of diversification on both the initial risk and risk contagion. Moreover, we find that the inverted U-shaped relationship between diversification and systemic risk is more significant when the assets correlate less. Finally, we propose new methods for measuring general networks’ level of diversification, for which average degree of company nodes divided by number of companies is affirmed to be more appropriate via simulations performed on different sized random networks and a further analysis of the 2007 U.S. commercial banks balance sheet data. The mechanism to generate the relationship between diversification and systemic risk—as well as their measurement methods—provide valuable references for networks’ risk control and structure optimization.

Keywords: Financial network; Diversification; Systemic risk; Initial risk; Contagion (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s10614-021-10211-9 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

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:kap:compec:v:61:y:2023:i:1:d:10.1007_s10614-021-10211-9

Ordering information: This journal article can be ordered from
http://www.springer. ... ry/journal/10614/PS2

DOI: 10.1007/s10614-021-10211-9

Access Statistics for this article

Computational Economics is currently edited by Hans Amman

More articles in Computational Economics from Springer, Society for Computational Economics Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().