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Stress testing the resilience of financial networks

Author

Listed:
  • Hamed Amini

    (TREC - Theory of networks and communications - DI-ENS - Département d'informatique - ENS Paris - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - Inria - Institut National de Recherche en Informatique et en Automatique - CNRS - Centre National de la Recherche Scientifique - Inria Paris-Rocquencourt - Inria - Institut National de Recherche en Informatique et en Automatique)

  • Rama Cont

    (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique)

  • Andreea Minca

    (MATHFI - Financial mathematics - Inria Paris-Rocquencourt - Inria - Institut National de Recherche en Informatique et en Automatique - ENPC - École des Ponts ParisTech - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12, LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique)

Abstract

We propose a simulation-free framework for stress testing the resilience of a financial network to external shocks affecting balance sheets. Whereas previous studies of contagion effects in financial networks have relied on large scale simulations, our approach uses a simple analytical criterion for resilience to contagion, based on an asymptotic analysis of default cascades in heterogeneous networks. In particular, our methodology does not require to observe the whole network but focuses on the characteristics of the network which contribute to its resilience. Applying this framework to a sample network, we observe that the size of the default cascade generated by a macroeconomic shock across balance sheets may exhibit a sharp transition when the magnitude of the shock reaches a certain threshold: Beyond this threshold, contagion spreads to a large fraction of the financial system. An upper bound is given for the threshold in terms of the characteristics of the network. http://www.worldscientific.com/doi/abs/10.1142/S0219024911006504

Suggested Citation

  • Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress testing the resilience of financial networks," Post-Print hal-00801538, HAL.
    • Handle: RePEc:hal:journl:hal-00801538
    DOI: 10.1142/S0219024911006504
    as

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