Sensitivity and computational complexity in financial networks

DOI10.3233/AF-160166zbMATH Open1396.91823arXiv1503.07676OpenAlexW2963793797MaRDI QIDQ4586453FDOQ4586453

Authors: Brett Hemenway, Sanjeev Khanna 

Publication date: 13 September 2018

Published in: Algorithmic Finance (Search for Journal in Brave)

Abstract: Modern financial networks exhibit a high degree of interconnectedness and determining the causes of instability and contagion in financial networks is necessary to inform policy and avoid future financial collapse. In the American Economic Review, Elliott, Golub and Jackson proposed a simple model for capturing the dynamics of complex financial networks. In Elliott, Golub and Jackson's model, each institution in the network can buy underlying assets or percentage shares in other institutions (cross-holdings) and if any institution's value drops below a critical threshold value, its value suffers an additional failure cost. This work shows that even in simple model put forward by Elliott, Golub and Jackson there are fundamental barriers to understanding the risks that are inherent in a network. First, if institutions are not required to maintain a minimum amount of self-holdings, an $epsilon$ change in investments by a single institution can have an arbitrarily magnified influence on the net worth of the institutions in the system. This sensitivity result shows that if institutions have small self-holdings, then estimating the market value of an institution requires almost perfect information about every cross-holding in the system. Second, we show that even if a regulator has complete information about all cross-holdings in the system, it may be computationally intractable to even estimate the number of failures that could be caused by an arbitrarily small shock to the system. Together, these results show that any uncertainty in the cross-holdings or values of the underlying assets can be amplified by the network to arbitrarily large uncertainty in the valuations of institutions in the network.

Full work available at URL: https://arxiv.org/abs/1503.07676

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zbMATH Keywords

sensitivitycomputational complexitynetwork analysisfinancial contagionnetwork stability

Mathematics Subject Classification ID

Analysis of algorithms and problem complexity (68Q25) Deterministic network models in operations research (90B10) Actuarial science and mathematical finance (91G99)

Cited In (9)

• Optimal connectivity for a large financial network
• Financial networks with singleton liability priorities
• Default ambiguity: finding the best solution to the clearing problem
• Certifiably pseudorandom financial derivatives
• Title not available (Why is that?)
• The price of complexity in financial networks
• On the computational complexity of measuring global stability of banking networks
• Financial networks with singleton liability priorities
• Network and eigenvalue analysis of financial transaction networks

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