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`Too interconnected to fail' financial network of US CDS market : topological fragility and systemic risk


Reference:

Markose, S., Giansante, S. and Shaghaghi, A. R., 2012. `Too interconnected to fail' financial network of US CDS market : topological fragility and systemic risk. Journal of Economic Behavior and Organization, 83 (3), 627–646.

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    Official URL:

    http://dx.doi.org/10.1016/j.jebo.2012.05.016

    Abstract

    A small segment of credit default swaps (CDS) on residential mortgage backed securities (RMBS) stand implicated in the 2007 financial crisis. The dominance of a few big players in the chains of insurance and reinsurance for CDS credit risk mitigation for banks' assets has led to the idea of too interconnected to fail (TITF) resulting, as in the case of AIG, of a tax payer bailout. We provide an empirical reconstruction of the US CDS network based on the FDIC Call Reports for off balance sheet bank data for the 4th quarter in 2007 and 2008. The propagation of financial contagion in networks with dense clustering which reflects high concentration or localization of exposures between few participants will be identified as one that is TITF. Those that dominate in terms of network centrality and connectivity are called `super-spreaders'. Management of systemic risk from bank failure in uncorrelated random networks is different to those with clustering. As systemic risk of highly connected financial firms in the CDS (or any other)financial markets is not priced into their holding of capital and collateral, we design a super-spreader tax based on eigenvector centrality of the banks which can mitigate potential socialized losses.

    Details

    Item Type Articles
    CreatorsMarkose, S., Giansante, S. and Shaghaghi, A. R.
    DOI10.1016/j.jebo.2012.05.016
    Uncontrolled Keywordscredit default swaps, financial networks, eigenvector centrality, financial contagion, systemic risk, super-spreader tax
    DepartmentsSchool of Management
    Publisher StatementGiansante_JEBO_2012_i.pdf: NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Economic Behavior & Organization. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Economic Behavior & Organization, vol 83, issue 3, 2012, DOI 10.1016/j.jebo.2012.05.016
    RefereedYes
    StatusPublished
    ID Code30029

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