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DebtRank: A microscopic foundation for shock propagation

Bardoscia, Marco and Battiston, Stefano and Caccioli, Fabio and Caldarelli, Guido DebtRank: A microscopic foundation for shock propagation. Working Paper ArXiv (Submitted)

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The DebtRank algorithm has been increasingly investigated as a method to estimate the impact of shocks in financial networks, as it overcomes the limitations of the traditional default-cascade approaches. Here we formulate a dynamical "microscopic" theory of instability for financial networks by iterating balance sheet identities of individual banks and by assuming a simple rule for the transfer of shocks from borrowers to lenders. By doing so, we generalise the DebtRank formulation, both providing an interpretation of the effective dynamics in terms of basic accounting principles and preventing the underestimation of losses on certain network topologies. Depending on the structure of leverages the dynamics is either stable, in which case the asymptotic state can be computed analytically, or unstable, meaning that at least a bank will default. We apply this results to a network of roughly 200 among the largest European banks in the period 2008 - 2013. We show that network effects generate an amplification of exogenous shocks of a factor ranging between three (in normal periods) and six (during the crisis), when we stress the system with a 0.5% shock on external (i.e. non-interbank) assets for all banks.

Item Type: Working Paper (Working Paper)
Subjects: H Social Sciences > HD Industries. Land use. Labor > HD61 Risk Management
Research Area: Economics and Institutional Change
Depositing User: Caterina Tangheroni
Date Deposited: 19 May 2015 11:15
Last Modified: 19 May 2015 11:15
URI: http://eprints.imtlucca.it/id/eprint/2687

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