The Stability of the Financial System

The recent financial crisis has revealed the intertwined nature of modern financial systems. At the same time, the crisis pointed at the necessity for the central banks to assure price stability, as well as the stability of the financial system.

The necessity of ensuring financial stability, as well as the necessity of formulating the Principles of Financial Regulation imply the need of defining as precisely as possible the Financial System.

The paper proposes a definition of the financial system and characterization of its structure, behavior and of its role within the economic mechanism.

To define the topology of the financial systems, we use concepts of Graph Theory (Network models) [Nier (2007), Eboli (2001)].

Every element of the financial system is defined as representing a node of the graph. On the basis of specific financial operators, we define the connections between the system’s elements, as well as the degree of connectedness of the system within the network.

As concerns the behavior of the financial system, we analyze the response of the system to exogenous shocks, as well as the way of engendering endogenous shocks [ Danielsson (2010)].

Eventually, we propose a metric to characterize the stability of the financial system [Goodhart (2009)].

 

 

Selected References

 

1. Nier,E. et al (2007):”Network Models and Financial Stability”, Journal of Economic Dynamics & Control 3A, pp. 2033-2060
2. Eboli, M. (2004): “Systemic Risk in Financial Network: a Graph Theoretical Approach”, Mimeo, Univ. di Chieti, Pescara
3. Danielsson, J. (2010): “Endogenous and Systemic Risk”, W.P., LSE
4. Goodhart, Ch., Segoviano, M. (2009): “Banking Stability Measures” ,IMF, WP 09/4