Complexity, stability and contagion in financial networks
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