Impact of Contingent Payments on Systemic Risk in Financial Networks

In this paper we introduce a generalized extension of the Eisenberg-Noe model of financial contagion to allow for time dynamics of the interbank liabilities, including a dynamic examination of default risk. This framework separates the cash account and long-term capital account to more accurately model the health of a financial institution. In doing so, such a system allows us to distinguish between delinquency and default as well as between defaults resulting from either ins...

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 eventual...

This paper provides a general framework for modeling financial contagion in a system with obligations in multiple illiquid assets (e.g., currencies). In so doing, we develop a multi-layered financial network that extends the single network of Eisenberg and Noe (2001). In particular, we develop a financial contagion model with fire sales that allows institutions to both buy and sell assets to cover their liabilities in the different assets and act as utility maximizers. We p...

In this work we introduce a model of default contagion that combines the approaches of Eisenberg-Noe interbank networks and dynamic mean field interactions. The proposed contagion mechanism provides an endogenous rule for early defaults in a network of financial institutions. The main result is to demonstrate a mean field interaction that can be found as the limit of the finite bank system generated from a finite Eisenberg-Noe style network. In this way, we connect two previo...

This paper proposes a novel dynamical model for determining clearing payments in financial networks. We extend the classical Eisenberg-Noe model of financial contagion to multiple time periods, allowing financial operations to continue after possible initial pseudo defaults, thus permitting nodes to recover and eventually fulfil their liabilities. Optimal clearing payments in our model are computed by solving a suitable linear program, both in the full matrix payments case an...

How, and to what extent, does an interconnected financial system endogenously amplify external shocks? This paper attempts to reconcile some apparently different views emerged after the 2008 crisis regarding the nature and the relevance of contagion in financial networks. We develop a common framework encompassing several network contagion models and show that, regardless of the shock distribution and the network topology, precise ordering relationships on the level of aggreg...

The current global financial system forms a highly interconnected network where a default in one of its nodes can propagate to many other nodes, causing a catastrophic avalanche effect. In this paper we consider the problem of reducing the financial contagion by introducing some targeted interventions that can mitigate the cascaded failure effects. We consider a multi-step dynamic model of clearing payments and introduce an external control term that represents corrective cas...

This paper provides a framework for modeling the financial system with multiple illiquid assets when liquidation of illiquid assets is caused by failure to meet a leverage requirement. This extends the network model of Cifuentes, Shin & Ferrucci (2005) which incorporates a single asset with fire sales and capital adequacy ratio. This also extends the network model of Feinstein (2015) which incorporates multiple illiquid assets with fire sales and no leverage ratios. We prove ...

As impressively shown by the financial crisis in 2007/08, contagion effects in financial networks harbor a great threat for the stability of the entire system. Without sufficient capital requirements for banks and other financial institutions, shocks that are locally confined at first can spread through the entire system and be significantly amplified by various contagion channels. The aim of this thesis is thus to investigate in detail two selected contagion channels of this...

We introduce a general model for the balance-sheet consistent valuation of interbank claims within an interconnected financial system. Our model represents an extension of clearing models of interdependent liabilities to account for the presence of uncertainty on banks' external assets. At the same time, it also provides a natural extension of classic structural credit risk models to the case of an interconnected system. We characterize the existence and uniqueness of a valua...