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Reverse stress testing interbank networks

Grigat, Daniel and Caccioli, Fabio (2017) Reverse stress testing interbank networks. Scientific Reports, 7 (1). p. 15616. ISSN 2045-2322

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Identification Number: 10.1038/s41598-017-14470-1

Abstract

We reverse engineer dynamics of financial contagion to find the scenario of smallest exogenous shock that, should it occur, would lead to a given final systemic loss. This reverse stress test can be used to identify the potential triggers of systemic events, and it removes the arbitrariness in the selection of shock scenarios in stress testing. We consider in particular the case of distress propagation in an interbank market, and we study a network of 44 European banks, which we reconstruct using data collected from banks statements. By looking at the distribution across banks of the size of smallest exogenous shocks we rank banks in terms of their systemic importance, and we show the effectiveness of a policy with capital requirements based on this ranking. We also study the properties of smallest exogenous shocks as a function of the parameters that determine the endogenous amplification of shocks. We find that the size of smallest exogenous shocks reduces and that the distribution across banks becomes more localized as the system becomes more unstable.

Item Type: Article
Official URL: https://www.nature.com/srep/
Additional Information: © 2017 The Authors © CC BY 4.0
Divisions: Systemic Risk Centre
Subjects: H Social Sciences > HD Industries. Land use. Labor > HD61 Risk Management
H Social Sciences > HG Finance
Sets: Research centres and groups > Systemic Risk Centre
Date Deposited: 12 Feb 2018 10:17
Last Modified: 12 Feb 2018 11:11
URI: http://eprints.lse.ac.uk/id/eprint/86746

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