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A Bayesian methodology for systemic risk assessment in financial networks

Gandy, Axel and Veraart, Luitgard A. M. (2017) A Bayesian methodology for systemic risk assessment in financial networks. Management Science, 63 (12). 4428 -4446. ISSN 0025-1909

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Identification Number: 10.1287/mnsc.2016.2546

Abstract

We develop a Bayesian methodology for systemic risk assessment in financial networks such as the interbank market. Nodes represent participants in the network and weighted directed edges represent liabilities. Often, for every participant, only the total liabilities and total assets within this network are observable. However, systemic risk assessment needs the individual liabilities. We propose a model for the individual liabilities, which, following a Bayesian approach, we then condition on the observed total liabilities and assets and, potentially, on certain observed individual liabilities. We construct a Gibbs sampler to generate samples from this conditional distribution. These samples can be used in stress testing, giving probabilities for the outcomes of interest. As one application we derive default probabilities of individual banks and discuss their sensitivity with respect to prior information included to model the network. An R-package implementing the methodology is provided.

Item Type: Article
Official URL: http://pubsonline.informs.org/journal/mnsc
Additional Information: © 2016 INFORMS
Divisions: Management
Subjects: H Social Sciences > HG Finance
Q Science > QA Mathematics
Sets: Departments > Management
Date Deposited: 04 May 2016 09:13
Last Modified: 20 May 2019 02:14
URI: http://eprints.lse.ac.uk/id/eprint/66312

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