Quantification of systemic risk from overlapping portfolios in the financial system

Poledna, Sebastian, Martínez-Jaramillo, Serafín, Caccioli, Fabio and Thurner, Stefan (2021) Quantification of systemic risk from overlapping portfolios in the financial system. Journal of Financial Stability, 52. ISSN 1572-3089

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Abstract

Financial markets create endogenous systemic risk, the risk that a substantial fraction of the system ceases to function and collapses. Systemic risk can propagate through different mechanisms and channels of contagion. One important form of financial contagion arises from indirect interconnections between financial institutions mediated by financial markets. This indirect interconnection occurs when financial institutions invest in common assets and is referred to as overlapping portfolios. In this work we quantify systemic risk from indirect interconnections between financial institutions. Complete information of security holdings of major Mexican financial intermediaries and the ability to uniquely identify securities in their portfolios, allows us to represent the Mexican financial system as a bipartite network of securities and financial institutions. This makes it possible to quantify systemic risk arising from overlapping portfolios. We show that focusing only on direct interbank exposures underestimates total systemic risk levels by up to 50% under the assumptions of the model. By representing the financial system as a multi-layer network of direct interbank exposures (default contagion) and indirect external exposures (overlapping portfolios) we estimate the mutual influence of different channels of contagion. The method presented here is the first quantification of systemic risk on national scales that includes overlapping portfolios.

Item Type:	Article
Official URL:	https://www.sciencedirect.com/journal/journal-of-f...
Additional Information:	© 2021 The Authors
Divisions:	Systemic Risk Centre
Subjects:	H Social Sciences > HG Finance H Social Sciences > HF Commerce
JEL classification:	D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D85 - Network Formation and Analysis: Theory G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
Date Deposited:	11 Feb 2022 12:15
Last Modified:	16 Nov 2024 08:24
URI:	http://eprints.lse.ac.uk/id/eprint/113734

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