IDEAS home Printed from https://ideas.repec.org/p/arx/papers/2103.10872.html
   My bibliography  Save this paper

Optimal Clearing Payments in a Financial Contagion Model

Author

Listed:
  • Giuseppe Calafiore
  • Giulia Fracastoro
  • Anton V. Proskurnikov

Abstract

Financial networks are characterized by complex structures of mutual obligations. These obligations are fulfilled entirely or in part (when defaults occur) via a mechanism called clearing, which determines a set of payments that settle the claims by respecting rules such as limited liability, absolute priority, and proportionality (pro-rated payments). In the presence of shocks on the financial system, however, the clearing mechanism may lead to cascaded defaults and eventually to financial disaster. In this paper, we first study the clearing model under pro-rated payments of Eisenberg and Noe, and we derive novel necessary and sufficient conditions for the uniqueness of the clearing payments, valid for an arbitrary topology of the financial network. Then, we argue that the proportionality rule is one of the factors responsible for cascaded defaults, and that the overall system loss can be reduced if this rule is lifted. The proposed approach thus shifts the focus from the individual interest to the overall system's interest to control and contain adverse effects of cascaded failures, and we show that clearing payments in this setting can be computed by solving suitable convex optimization problems.

Suggested Citation

  • Giuseppe Calafiore & Giulia Fracastoro & Anton V. Proskurnikov, 2021. "Optimal Clearing Payments in a Financial Contagion Model," Papers 2103.10872, arXiv.org, revised Feb 2024.
    • Handle: RePEc:arx:papers:2103.10872
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/2103.10872
    File Function: Latest version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Hamed Amini & Damir Filipović & Andreea Minca, 2016. "To Fully Net or Not to Net: Adverse Effects of Partial Multilateral Netting," Operations Research, INFORMS, vol. 64(5), pages 1135-1142, October.
    2. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2015. "Systemic Risk and Stability in Financial Networks," American Economic Review, American Economic Association, vol. 105(2), pages 564-608, February.
    3. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Risk Assessment for Banking Systems," Management Science, INFORMS, vol. 52(9), pages 1301-1314, September.
    4. Péter Csóka & P. Jean-Jacques Herings, 2018. "Decentralized Clearing in Financial Networks," Management Science, INFORMS, vol. 64(10), pages 4681-4699, October.
    5. Helmut Elsinger, 2009. "Financial Networks, Cross Holdings, and Limited Liability," Working Papers 156, Oesterreichische Nationalbank (Austrian Central Bank).
    6. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    7. Glasserman, Paul & Young, H. Peyton, 2016. "Contagion in financial networks," LSE Research Online Documents on Economics 68681, London School of Economics and Political Science, LSE Library.
    8. Matthew Elliott & Benjamin Golub & Matthew O. Jackson, 2014. "Financial Networks and Contagion," American Economic Review, American Economic Association, vol. 104(10), pages 3115-3153, October.
    9. Shin, Hyun Song, 2008. "Risk and liquidity in a system context," Journal of Financial Intermediation, Elsevier, vol. 17(3), pages 315-329, July.
    10. Paul Glasserman & H. Peyton Young, 2016. "Contagion in Financial Networks," Journal of Economic Literature, American Economic Association, vol. 54(3), pages 779-831, September.
    11. Leonardo Massai & Giacomo Como & Fabio Fagnani, 2019. "Equilibria and Systemic Risk in Saturated Networks," Papers 1912.04815, arXiv.org, revised Jan 2021.
    12. L. C. G. Rogers & L. A. M. Veraart, 2013. "Failure and Rescue in an Interbank Network," Management Science, INFORMS, vol. 59(4), pages 882-898, April.
    13. Tom Fischer, 2014. "No-Arbitrage Pricing Under Systemic Risk: Accounting For Cross-Ownership," Mathematical Finance, Wiley Blackwell, vol. 24(1), pages 97-124, January.
    14. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
    15. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
    16. Andrew G. Haldane & Robert M. May, 2011. "Systemic risk in banking ecosystems," Nature, Nature, vol. 469(7330), pages 351-355, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Giuseppe C. Calafiore & Giulia Fracastoro & Anton V. Proskurnikov, 2022. "Clearing Payments in Dynamic Financial Networks," Papers 2201.12898, arXiv.org, revised May 2022.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bardoscia, Marco & Barucca, Paolo & Brinley Codd, Adam & Hill, John, 2017. "The decline of solvency contagion risk," Bank of England working papers 662, Bank of England.
    2. Bardoscia, Marco & Barucca, Paolo & Codd, Adam Brinley & Hill, John, 2019. "Forward-looking solvency contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    3. Péter Csóka & P. Jean-Jacques Herings, 2021. "An Axiomatization of the Proportional Rule in Financial Networks," Management Science, INFORMS, vol. 67(5), pages 2799-2812, May.
    4. Giuseppe C. Calafiore & Giulia Fracastoro & Anton V. Proskurnikov, 2022. "Clearing Payments in Dynamic Financial Networks," Papers 2201.12898, arXiv.org, revised May 2022.
    5. Nicolas Houy & Frédéric Jouneau & François Le Grand, 2020. "Defaulting firms and systemic risks in financial networks: a normative approach," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(2), pages 503-526, September.
    6. Spiros Bougheas & Adam Hal Spencer, 2022. "Fire sales and ex ante valuation of systemic risk: A financial equilibrium networks approach," Discussion Papers 2022/04, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    7. Covi, Giovanni & Gorpe, Mehmet Ziya & Kok, Christoffer, 2021. "CoMap: Mapping Contagion in the Euro Area Banking Sector," Journal of Financial Stability, Elsevier, vol. 53(C).
    8. Marco Bardoscia & Paolo Barucca & Stefano Battiston & Fabio Caccioli & Giulio Cimini & Diego Garlaschelli & Fabio Saracco & Tiziano Squartini & Guido Caldarelli, 2021. "The Physics of Financial Networks," Papers 2103.05623, arXiv.org.
    9. Aikman, David & Beale, Daniel & Brinley-Codd, Adam & Covi, Giovanni & Hüser, Anne‑Caroline & Lepore, Caterina, 2023. "Macroprudential stress‑test models: a survey," Bank of England working papers 1037, Bank of England.
    10. Paolo Barucca & Marco Bardoscia & Fabio Caccioli & Marco D'Errico & Gabriele Visentin & Guido Caldarelli & Stefano Battiston, 2020. "Network valuation in financial systems," Mathematical Finance, Wiley Blackwell, vol. 30(4), pages 1181-1204, October.
    11. Giuseppe Calafiore & Giulia Fracastoro & Anton Proskurnikov, 2024. "Default Resilience and Worst-Case Effects in Financial Networks," Papers 2403.10631, arXiv.org.
    12. Christoph Siebenbrunner, 2017. "Clearing algorithms and network centrality," Papers 1706.00284, arXiv.org.
    13. Ahn, Dohyun & Kim, Kyoung-Kuk & Kwon, Eunji, 2023. "Multivariate stress scenario selection in interbank networks," Journal of Economic Dynamics and Control, Elsevier, vol. 154(C).
    14. Ketelaars, Martijn & Borm, Peter & Herings, P.J.J., 2023. "Duality in Financial Networks," Other publications TiSEM 26750293-9599-4e05-9ae1-8, Tilburg University, School of Economics and Management.
    15. Barnett, William A. & Wang, Xue & Xu, Hai-Chuan & Zhou, Wei-Xing, 2022. "Hierarchical contagions in the interdependent financial network," Journal of Financial Stability, Elsevier, vol. 61(C).
    16. Hitoshi Hayakawa, 2020. "Liquidity in Financial Networks," Computational Economics, Springer;Society for Computational Economics, vol. 55(1), pages 253-301, January.
    17. Jose Arreola Hernandez & Sang Hoon Kang & Ron P. McIver & Seong-Min Yoon, 2021. "Network Interdependence and Optimization of Bank Portfolios from Developed and Emerging Asia Pacific Countries," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 28(4), pages 613-647, December.
    18. Giansante, Simone & Manfredi, Sabato & Markose, Sheri, 2023. "Fair immunization and network topology of complex financial ecosystems," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 612(C).
    19. Valentina Macchiati & Giuseppe Brandi & Tiziana Di Matteo & Daniela Paolotti & Guido Caldarelli & Giulio Cimini, 2022. "Systemic liquidity contagion in the European interbank market," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 17(2), pages 443-474, April.
    20. Navarro, Noemí & Tran, Dan H., 2018. "Shock Diffusion in Regular Networks: The Role of Transitive Cycles," MPRA Paper 86267, University Library of Munich, Germany.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:2103.10872. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: arXiv administrators (email available below). General contact details of provider: http://arxiv.org/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.