Complexity, stability and contagion in financial networks

Saturday, 6 April 2013: 8:30 AM
Moisa Altar, Ph.D , Doctoral School of Finance and Banking, Romanian - American University, Bucharest, Romania
Judita Samuel, Ph.D. , Department of Computer Science, Romanian - American University, Bucharest, Romania
Adam Altăr Samuel, Ph., D, Student , Department of Computer Science for Business Management, Romanian - American University, Bucharest, Bucharest, Romania
The recent global financial crisis has illustrated the role of financial linkages as a channel for the propagation of shocks. In this paper we highlight  how network analysis can be used to gain a better understanding of the financial system and enhance its stability.

We analyze three important transmission channels: a) liquidity hoarding; b) asset price contagion and  c) the propagation of losses which may occur if banks default on their obligations to other banks in the interbank market.

In the context of complex financial networks a number of different entropy measures have been introduced: Gibbs entropy, Shannon entropy and von Neumann  entropy. We propose a new approach to assess systemic financial stability of a banking system using standard tools from modern risk management in combination with a network model of interbank loans.

A stability indicator of the system is defined, based on solving  an  optimization problem regarding the entropy of the system. We propose an  algorithm for solving this optimization problem.

Key words: financial networks, contagion, entropy, complexity