Systemic Risk from Global Financial Derivatives: A Network Analysis of Contagion and Its Mitigation with Super-Spreader Tax
Financial network analysis is used to provide firm level bottom-up holistic visualizations of interconnections of financial obligations in global OTC derivatives markets. This helps to identify Systemically Important Financial Intermediaries (SIFIs), analyse the nature of contagion propagation, and also monitor and design ways of increasing robustness in the network. Based on 2009 FDIC and individually collected firm level data covering gross notional, gross positive (negative) fair value and the netted derivatives assets and liabilities for 202 financial firms which includes 20 SIFIs, the bilateral flows are empirically calibrated to reflect data-based constraints. This produces a tiered network with a distinct highly clustered central core of 12 SIFIs that account for 78 percent of all bilateral exposures and a large number of financial intermediaries (FIs) on the periphery. The topology of the network results in the “Too- Interconnected-To-Fail” (TITF) phenomenon in that the failure of any member of the central tier will bring down other members with the contagion coming to an abrupt end when the ‘super-spreaders’ have demised. As these SIFIs account for the bulk of capital in the system, ipso facto no bank among the top tier can be allowed to fail, highlighting the untenable implicit socialized guarantees needed for these markets to operate at their current levels. Systemic risk costs of highly connected SIFIs nodes are not priced into their holding of capital or collateral. An eigenvector centrality based ‘super-spreader’ tax has been designed and tested for its capacity to reduce the potential socialized losses from failure of SIFIs.
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Financial Network Analysis
Contagion and Stability Analysis
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adjacency matrix Bank of America bilaterally netted capital surcharge clustering coefficient core counterparties Credit default degree distribution denoted derivatives assets derivatives liabilities derivatives markets derivatives products dynamics Economic eigen-pair empirically calibrated equation escrow exposures failed FDIC Figure financial contagion Financial Derivatives financial network financial system fund Furfine contagion Giakkoupis Giansante given GNFV Goldman Sachs gross market value gross notional Hence highly clustered inﬂict instability interbank interconnected joint portfolio JP Morgan large number left eigenvector macro-prudential market share Markose matrix 9 maximum eigenvalue Network Analysis network stability network statistics network structure network topology non-negative OTC derivatives Paper percent periphery probability of failure random graph reﬂect right eigenvector centrality row sums Segoviano SIFIs Singh small world networks socialized losses Stress Test super-spreader tax systemic risk costs systemic risk index systemic risk measures Table tax rates Tier 1 capital TITF trigger bank trillion US$350 billion vector