Project Discription
The Current Crisis in the Financial Sector and Deficits in Economic Research
The field of economics was caught completely unprepared for the current
financial crisis.
It thus seems to many that it has obviously ignored many important
factors and relationships relevant to financial markets.
The inability of economic models to recognize developments that
exacerbate crises and to capture developments observed in the real world
has led to a heated debate about methodological deficits in this field.
Paul Krugman, a 2008 Nobel Prize winner, has stated for example that the
last 30 years of macroeconomic and financial market research have been
“spectacularly useless at best, and positively harmful at worst” (cf.,
The Economist, July 16th, 2009).
Others have emphasized that economists are partially responsible for
negligence of the distortions in the financial sector,
since their prevailing models paint an illusionist picture of a
financial sector that is perfectly frictionless.
It has also been argued that their axiomatic approaches served, without
being validated empirically,
as the intellectual basis for the thoroughgoing liberalization of
financial markets that has finally led to the current crisis.
In the prevailing macroeconomic models, the financial sector indeed
plays only a very rudimentary role: the central bank sets the interest
rate,
which in turn affects the consumption and savings decisions of
households. The actual actors in the financial sector and the many types
of transactions made there do not really play a role in these models.
Phenomena such as speculative bubbles, overinvestment, the effects of
balance sheet changes and liquidity, and the domino effects of bank
bankruptcies are excluded a priori.
The origination of distortions in the financial sector and their spread
to the real economy is not compatible with the basic structure of these
models.
The way the financial crisis has played out thus demands that
macroeconomic research be given a new direction in many respects.
On the one hand, the internal structure of the much differentiated
global financial sector and its intrinsic destabilization potential need
to be studied.
On the other hand, the spread of the crisis from the banking sector to
the business sector needs to be studied.
The former will be the primary object of study in the project proposed
here, since the network structure of the financial sector is not well
researched.
Understanding these networks appears to be of central importance in
analyzing systemic instabilities.
It provides the scientific background for the much emphasized
macroprudential approach to regulating the banking sector,
an approach that is supposed to take into account not only bank-specific
risks but also the system-wide risk factors currently ignored.
Download the complete outline of the project as a pdf file:
Network Effects and Systemic Risk in the Banking Sector
Working Papers
Hubs and resilience: towards more realisitic models of the interbank markets
by M. Montagna and T. Lux
Abstract:
This paper uses a toy financial system to study systemic risk in
scale-free interbank networks.
Networks are produced according to a fitness algorithm, combined with a
representation of the balance sheets of the banks.
Our generating processes for interbank networks are designed in a way to
reproduce the frequently documented features of disassortative
behavior,
power laws in the degree distributions and power laws in the
distribution of bank sizes. The results show the presence of
a particular shell structure affecting the spread of an endogenous
shock.
Network
Analysis of the e-Mid Overnight Money Market: The Informational Value
of Different Aggregation Levels for Intrinsic Dynamic Processes
by K. Finger, D. Fricke and T. Lux
Abstract:
In this paper, we analyze the network properties of the Italian e-MID data based on overnight loans
during the period 1999-2010. We show that the networks appear to be random at the daily level, but contain
significant non-random structure for longer aggregation periods. In this sense, the daily networks cannot
be considered as being representative for the underlying `latent' network. Rather, the development of
various network statistics under time aggregation points toward strong non-random determinants of link
formation. We also identify the global financial crisis as a significant structural break for many network
measures.
On the Distribution of Links in the Interbank Network: Evidence from the e-MID Overnight Money Market
by D. Fricke and T. Lux
Abstract:
Previous literature on statistical properties of interbank loans has reported various power-laws,
particularly for the degree distribution (i.e. the distribution of credit links between institutions).
In this paper, we revisit data for the Italian interbank network based on overnight loans recorded on
the e-MID trading platform during the period 1999-2010 using both daily and quarterly aggregates.
In con- trast to previous authors, we find no evidence in favor of scale-free networks.
Rather, the data are best described by negative Binomial distributions.
For quarterly data, Weibull, Gamma, and Exponential distributions tend to provide comparable ts.
We find comparable re- sults when investigating the distribution of the number of transactions, even though in
this case the tails of the quarterly variables are much fatter. The absence of power-law behavior casts
doubts on the claim that interbank data fall into the category of scale-free networks.
Structure in the Italian Overnight Loan Market
by M. Raddant
Abstract:
We analyze the Italian interbank loan market from 1999 until 2010. The
analysis of net trade flows shows a high imbalance caused by few large
net borrowers in the market.
The trading volume shows a significant drop starting in 2007, which
accelerates with the Lehman default in late 2008. The network, based on
trading relationships, is very dense.
Hence, we try to identify strong links by looking for preferential
lending relationships expressed by discounts in the loan rate.
Furthermore, we estimate the dynamics of credit spreads for each bank
and find that economically significant spreads for the overnight market
only developed in 2010.
The analysis of bilateral loan relationships reveals that in the
pre-crisis era large net borrowers used to borrow at a slight discount.
In the post-Lehman era borrowers with large net exposures paid more than
the average market rate, which shows that the risk evaluation of market
participants has changed considerably.
Trading Strategies in the Overnight Money Market: Evidence from the e-MID Trading Platform
by T. Lux and D. Fricke
Abstract:
We explore the network topology arising from a dataset of the overnight
interbank transactions on the e-MID trading platform from January 1999
to December 2010.
In order to shed light on the hierarchical structure of the banking
system, we estimate different versions of a core-periphery model.
Our main findings are: (1) A core-periphery structure provides a better
fit for these interbank data than alternative network models, (2) the
identified core is quite stable over time,
consisting of roughly 28% of all banks before the global financial
crisis (GFC) and 23% afterwards, (3) the majority of core banks can be
classified as intermediaries,
i.e. as banks both borrowing and lending money, (4) allowing for
asymmetric `coreness’ with respect to lending and borrowing considerably
improves the fit,
and reveals more concentration in borrowing than lending activity of
money center banks. During the financial crisis of 2008, the reduction
of interbank lending was mainly due to core banks’
reducing their numbers of active outgoing links.
Network
Analysis of the e-MID Overnight Money Market: The Informational Value
of Different Aggregation Levels for Intrinsic Dynamic Processes
by K. Finger, D. Fricke and T. Lux
Abstract:
In this paper, we analyze the network properties of the Italian e-MID
data based on overnight loans during the period 1999-2010. We show that
the networks appear to be random at the daily level, but contain
significant non-random structure for longer aggregation periods. In this
sense, the daily networks cannot be considered as being representative
for the underlying `latent' network. Rather, the development of various
network statistics under time aggregation points toward strong
non-random determinants of link formation. We also identify the global
financial crisis as a significant structural break for many network
measures.
The Small Core of the German Corporate Board Network: New Evidence from 2010
by M. Milaković, S. Alfarano and T. Lux
Abstract:
Milaković, Alfarano and Lux (2010) have identified a small core of
directors who are both highly central to the entire network of German
corporate boards as well as closely connected among themselves.
While their analysis has been based on data for the management and
supervisory boards of a sample of 287 publicly traded companies with
high market capitalization as of May 2008, a subsequent study by
Milakovic',
Raddant and Birg (2010) using somewhat smaller samples from the years
1993, 1999, and 2005 has confirmed that this closely connected core is a
persistent stylized fact for the German corporate sector.
In this note, we provide an update of our previous results using the
composition of management and supervisory boards as of December, 2010.
Again, almost all qualitative properties of previous samples are
confirmed despite considerable turnover within the group of persons
constituting the network core.
Evolvement of Uniformity and Volatility in the Stressed Global Financial Village
by D.Y. Kenett, M. Raddant, T. Lux and E. Ben-Jacob
Abstract:
In the current era of strong worldwide market couplings the global
financial village became highly prone to systemic collapses, events that
can rapidly sweep through out the entire village.
Here we present a new methodology to assess and quantify inter-market
relations. The approach is based on the correlations between the market
index, the index volatility,
the market Index Cohesive Force and the meta-correlations (correlations
between the intra-correlations.) We investigated the relations between
six important world markets - U.S., U.K., Germany,
Japan, China and India from January 2000 until December 2010. We found
that while the developed ``western'' markets (U.S., U.K., Germany), are
highly correlated, the interdependencies
between these markets and the developing ``eastern'' markets (India and
China) are very volatile and with noticeable maxima at times of global
world events (2001: 9/11-attacks, 2003:
Iraq war, SARS, etc). The Japanese market switches ``identity'' - it
switches between periods of high meta-correlations with the ``western''
markets and periods that it behaves more similar to the ``eastern''
markets.
These and additional reported findings illustrate that the
methodological framework provides a way to quantify the evolvement of
interdependencies in the global market,
to evaluate a world financial network and quantify changes in the world
inter market relations. Such changes can be used as precursors to the
agitation of the global financial village.
Hence, the new approach can help to develop a sensitive ``financial
seismograph'' to detect early signs of global financial crises so they
can be treated before developed into world wide events.
