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Stability analysis of financial contagion due to overlapping portfolios

Common asset holdings are widely believed to have been the primary vector of contagion in the recent financial crisis. We develop a network approach to the amplification of financial contagion due to the combination of overlapping portfolios and leverage, and we show how it can be understood in terms of a generalized branching process. By studying a stylized model we estimate the circumstances under which systemic instabilities are likely to occur as a function of parameters such as leverage, market crowding, diversification, and market impact. Although diversification may be good for individual institutions, it can create dangerous systemic effects, and as a result financial contagion gets worse with too much diversification. Under our model there is a critical threshold for leverage; below it financial networks are always stable, and above it the unstable region grows as leverage increases. The financial system exhibits "robust yet fragile" behavior, with regions of the parameter space where contagion is rare but catastrophic whenever it occurs. Our model and methods of analysis can be calibrated to real data and provide simple yet powerful tools for macroprudential stress testing.

 

Stability analysis of financial contagion due to overlapping portfolios

Fabio Caccioli, Munik Shrestha, Cristopher Moore, J. Doyne Farmer

http://arxiv.org/abs/1210.5987


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FuturICT: Complexity aided design -A. Carbone, M. Ajmone-Marsan, K. W. Axhausen, M. Batty, M. Masera, E. Rome

FuturICT: Complexity aided design -A. Carbone, M. Ajmone-Marsan, K. W. Axhausen, M. Batty, M. Masera, E. Rome | FuturICT Journal Publications | Scoop.it

A. Carbone, M. Ajmone-Marsan, K. W. Axhausen, M. Batty, M. Masera, E. Rome

“In the next century, planet earth will don an electronic skin. It will use the Internet as a scaffold to support and transmit its sensations. This skin is already being stitched together. It consists of millions of embedded electronic measuring devices: thermostats, pressure gauges, pollution detectors, cameras, microphones, glucose sensors, EKGs, electroencephalographs. These will probe and monitor cities and endangered species, the atmosphere, our ships, highways and fleets of trucks, our conversations, our bodies–even our dreams ....What will the earth’s new skin permit us to feel? How will we use its surges of sensation? For several years–maybe for a decade–there will be no central nervous system to manage this vast signaling network. Certainly there will be no central intelligence...some qualities of self-awareness will emerge once the Net is sensually enhanced. Sensuality is only one force pushing the Net toward intelligence”. These statements are quoted by an interview by Cherry Murray, Dean of the Harvard School of Engineering and Applied Sciences and Professor of Physics. It is interesting to outline the timeliness and highly predicting power of these statements. In particular, we would like to point to the relevance of the question “What will the earth’s new skin permit us to feel?” to the work we are going to discuss in this paper. There are many additional compelling questions, as for example: “How can the electronic earth’s skin be made more resilient?”; “How can the earth’s electronic skin be improved to better satisfy the need of our society?”;“What can the science of complex systems contribute to this endeavour?”

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JOURNAL: THE EUROPEAN PHYSICAL JOURNAL SPECIAL TOPICS Vol. 214 (November II 2012)"Participatory Science and Computing for Our Complex World".

http://epjst.epj.org/index.php?option=com_toc&url=/articles/epjst/abs/2012/14/contents/contents.html

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