Double cascade model of financial crises

DOI10.1142/S0219024916500412MaRDI QIDQ2816958zbMATH OpenOpenAlexFDO

Authors T. R. Hurd, Davide Cellai, Sergey Melnik, Quentin H. Shao

Publication date 26 August 2016

Published in International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1310.6873

zbMATH Keywords

banking networkcontagiondefaultfunding liquidityliquidity hoardingrandom graphsystemic risk

Mathematics Subject Classification ID

Random graphs (graph-theoretic aspects) (05C80) Corporate finance (dividends, real options, etc.) (91G50)

Abstract: The scope of financial systemic risk research encompasses a wide range of interbank channels and effects, including asset correlation shocks, default contagion, illiquidity contagion, and asset fire sales. This paper introduces a financial network model that combines the default and liquidity stress mechanisms into a "double cascade mapping". The progress and eventual result of the crisis is obtained by iterating this mapping to its fixed point. Unlike simpler models, this model can therefore quantify how illiquidity or default of one bank influences the overall level of liquidity stress and default in the system. Large-network asymptotic cascade mapping formulas are derived that can be used for efficient network computations of the double cascade. Numerical experiments then demonstrate that these asymptotic formulas agree qualitatively with Monte Carlo results for large finite networks, and quantitatively except when the initial system is placed in an exceptional "knife-edge" configuration. The experiments clearly support the main conclusion that when banks respond to liquidity stress by hoarding liquidity, then in the absence of asset fire sales, the level of defaults in a financial network is negatively related to the strength of bank liquidity hoarding and the eventual level of stress in the network.

Recommendations

• Systemic cascades on inhomogeneous random financial networks
• Inhomogeneous financial networks and contagious links
• Managing Default Contagion in Inhomogeneous Financial Networks
• An integrated model for fire sales and default contagion

Cites work

• Contagion in financial networks
• Contagion! Systemic risk in financial networks
• Directed scale-free graphs
• Liaisons dangereuses: increasing connectivity, risk sharing, and systemic risk
• On Watts' cascade model with random link weights
• Systemic risk in financial systems

Cited in

(7)

• On fairness of systemic risk measures
• Systemic cascades on inhomogeneous random financial networks
• Bank liquidity and the global financial crisis
• The construction and properties of assortative configuration graphs
• Bank panics and fire sales, insolvency and illiquidity
• A unified approach to systemic risk measures via acceptance sets
• Brief synopsis of the scientific career of T. R. Hurd

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