Stress testing the resilience of financial networks

Hamed Amini (), Rama Cont () and Andreea Minca
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Hamed Amini: TREC - Theory of networks and communications - DI-ENS - Département d'informatique - ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - Inria - Institut National de Recherche en Informatique et en Automatique - CNRS - Centre National de la Recherche Scientifique - Inria Paris-Rocquencourt - Inria - Institut National de Recherche en Informatique et en Automatique
Rama Cont: LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique
Andreea Minca: MATHFI - Financial mathematics - Inria Paris-Rocquencourt - Inria - Institut National de Recherche en Informatique et en Automatique - ENPC - École nationale des ponts et chaussées - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12, LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique

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Abstract: We propose a simulation-free framework for stress testing the resilience of a financial network to external shocks affecting balance sheets. Whereas previous studies of contagion effects in financial networks have relied on large scale simulations, our approach uses a simple analytical criterion for resilience to contagion, based on an asymptotic analysis of default cascades in heterogeneous networks. In particular, our methodology does not require to observe the whole network but focuses on the characteristics of the network which contribute to its resilience. Applying this framework to a sample network, we observe that the size of the default cascade generated by a macroeconomic shock across balance sheets may exhibit a sharp transition when the magnitude of the shock reaches a certain threshold: Beyond this threshold, contagion spreads to a large fraction of the financial system. An upper bound is given for the threshold in terms of the characteristics of the network. http://www.worldscientific.com/doi/abs/10.1142/S0219024911006504

Keywords: ystemic risk; random graphs; stress test; default risk; macro-prudential regulation (search for similar items in EconPapers)
Date: 2012-01-03
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Citations: View citations in EconPapers (35)

Published in International Journal of Theoretical and Applied Finance, 2012, 15 (1), pp.1250006-1250026. ⟨10.1142/S0219024911006504⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00801538

DOI: 10.1142/S0219024911006504

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