Stefano Battiston, Antoine Mandel, Irene Monasterolo, Franziska Schuetze, Gabriele Visentin, A Climate stress-test of the financial system, Nature Climate Change, Vol. 7, 2017. (Journal Article)
The urgency of estimating the impact of climate risks on the financial system is increasingly recognized among scholars and practitioners. By adopting a network approach to financial dependencies, we look at how climate policy risk might propagate through the financial system. We develop a network-based climate stress-test methodology and apply it to large Euro Area banks in a ‘green’ and a ‘brown’ scenario. We find that direct and indirect exposures to climate-policy-relevant sectors represent a large portion of investors’ equity portfolios, especially for investment and pension funds. Additionally, the portion of banks’ loan portfolios exposed to these sectors is comparable to banks’ capital. Our results suggest that climate policy timing matters. An early and stable policy framework would allow for smooth asset value adjustments and lead to potential net winners and losers. In contrast, a late and abrupt policy framework could have adverse systemic consequences. |
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Jorge Abad, Marco D'Errico, Neill Killeen, Vera Luz, Tuomas Peltonen, Richard Portes, Teresa Urbano, Mapping the interconnectedness between EU banks and shadow banking entities, In: NBER Working Paper Series, No. 23280, 2017. (Working Paper)
This paper provides a unique snapshot of the exposures of EU banks to shadow banking entities within the global financial system. Drawing on a rich and novel dataset, the paper documents the cross-sector and cross-border linkages and considers which are the most relevant for systemic risk monitoring. From a macroprudential perspective, the identification of potential feedback and contagion channels arising from the linkages of banks and shadow banking entities is particularly challenging when shadow banking entities are domiciled in different jurisdictions. The analysis shows that many of the EU banks’ exposures are towards non-EU entities, particularly US-domiciled shadow banking entities. At the individual level, banks’ exposures are diversified although this diversification leads to high overlap across different types of shadow banking entities. |
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Central Banking Newsdesk, Marco D'Errico, Shadow banking links leave EU banks vulnerable – ESRB paper, In: Central Banking, 15 March 2017. (Media Coverage)
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Jan Werner, Distress Propagation in the EU Banking System: Assessing Cross-Country Sovereign Debt Exposures, University of Zurich, Faculty of Business, Economics and Informatics, 2017. (Master's Thesis)
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Marco D'Errico, Tarik Roukny, Compressing over-the-counter markets, In: European Systemic Risk Board Working Paper Series (ESRB), No. 44, 2017. (Working Paper)
In this paper, we show both theoretically and empirically that the size of over-the-counter (OTC) markets can be reduced without affecting individual net positions. First, we find that the networked nature of these markets generates an excess of notional obligations between the aggregate gross amount and the minimum amount required to satisfy each individual net position. Second, we show conditions under which such excess can be removed. We refer to this netting operation as compression and identify feasibility and effciency criteria, highlighting intermediation as the key element for excess levels. We show that a trade-off exists between the amount of notional that can be eliminated from the system and the conservation of original trading relationships. Third, we apply our framework to a unique and comprehensive transaction-level dataset on OTC derivatives including all firms based in the European Union. On average, we find that around 75% of market gross notional relates to excess. While around 50% can in general be removed via bilateral compression, more sophisticated multilateral compression approaches are substantially more effcient. In particular, we find that even the most conservative multilateral approach which satisfies relationship constraints can eliminate up to 98% of excess in the markets. |
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Veronika Stolbova, Stefano Battiston, Mauro Napoletano, Andrea Roventini, Financialization of Europe: a comparative perspective, In: ISIGrowth, No. 22, 2017. (Working Paper)
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Steffen Schuldenzucker, Sven Seuken, Stefano Battiston, The Computational Complexity of Clearing Financial Networks with Credit Default Swaps, In: ArXiv.org, No. 1710.01578, 2017. (Working Paper)
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Andreas Karpf, Antoine Mandel, Stefano Battiston, Price and Network Dynamics in the European Carbon Market, In: EconPapers, No. -, 2017. (Working Paper)
This paper presents an analysis of the European Emission Trading System as a transaction network. It is shown that, given the lack of a centralized market place, industrial actors had to resort to local connections and financial intermediaries to participate in the market. This gave rise to a hierarchical structure in the transaction network. To empirically relate networks statistics to market outcomes a PLS-PM modeling technique is introduced. It is shown that the asymmetries in the network induced market inefficiencies (e.g. increased bid-ask spread). Albeit the efficiency of the market has improved from the beginning of Phase II, the asymmetry persists, imposing unnecessary additional costs on agents and reducing the effectiveness of the market as a mitigation instrument. |
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Marco Bardoscia, Stefano Battiston, Fabio Caccioli, Guido Caldarelli, Pathways towards instability in financial networks, Nature Communications, Vol. 8, 2017. (Journal Article)
Following the financial crisis of 2007–2008, a deep analogy between the origins of instability in financial systems and complex ecosystems has been pointed out: in both cases, topological features of network structures influence how easily distress can spread within the system. However, in financial network models, the details of how financial institutions interact typically play a decisive role, and a general understanding of precisely how network topology creates instability remains lacking. Here we show how processes that are widely believed to stabilize the financial system, that is, market integration and diversification, can actually drive it towards instability, as they contribute to create cyclical structures which tend to amplify financial distress, thereby undermining systemic stability and making large crises more likely. This result holds irrespective of the details of how institutions interact, showing that policy-relevant analysis of the factors affecting financial stability can be carried out while abstracting away from such details. |
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Marco D'Errico, Stefano Battiston, Tuomas Peltonen, Martin Scheicher, How does risk flow in the credit default swap market?, In: European Systemic Risk Board Working Paper Series (ESRB), No. 33, 2016. (Working Paper)
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Angelos Antonopoulos, Chiara Perillo, Christos Verikoukis, Internet Service Providers vs. Over-the-Top Companies Friends or Foes?, SIGMETRICS Performance Evaluation Review, Vol. 44 (3), 2016. (Journal Article)
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Stefano Battiston, An Zeng, The multiplex network of EU lobby organizations, PLoS ONE, Vol. 11 (10), 2016. (Journal Article)
The practice of lobbying in the interest of economic or social groups plays an important role in the policy making process of most economies. We carry out a multi-level network analysis of the relations among lobbying organizations in the EU transparency register, focusing on the domain of finance and climate. We find that the network centrality of organizations has no simple relation with their size and each layer provides additional complementary information to characterize organizations' influence. At a more aggregate level, groups of interest differ very much in terms of internal cohesiveness and thus in their ability to advocate coherently. Groups also differ in their centrality and thus in their ability to influence each other. |
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Central Banking Newsdesk, Marco D'Errico, ESRB publishes guide to OTC derivatives database, In: Central Banking, 22 September 2016. (Media Coverage)
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Stefano Battiston, Guido Caldarelli, Robert M May, Tarik Roukny, Joseph E Stiglitz, The price of complexity in financial networks, Proceedings of the National Academy of Sciences of the United States of America, Vol. 113 (36), 2016. (Journal Article)
Financial institutions form multilayer networks by engaging in contracts with each other and by holding exposures to common assets. As a result, the default probability of one institution depends on the default probability of all of the other institutions in the network. Here, we show how small errors on the knowledge of the network of contracts can lead to large errors in the probability of systemic defaults. From the point of view of financial regulators, our findings show that the complexity of financial networks may decrease the ability to mitigate systemic risk, and thus it may increase the social cost of financial crises. |
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Stefano Battiston, Guido Caldarelli, Marco D'Errico, Stefano Gurciullo, Leveraging the network: a stress-test framework based on DebtRank, Statistics & Risk Modeling, Vol. 33 (3-4), 2016. (Journal Article)
We develop a novel stress-test framework to monitor systemic risk in financial systems. The modular structure of the framework allows to accommodate for a variety of shock scenarios, methods to estimate interbank exposures and mechanisms of distress propagation. The main features are as follows. First, the framework allows to estimate and disentangle not only first-round effects (i.e. shock on external assets) and second-round effects (i.e. distress induced in the interbank network), but also third-round effects induced by possible fire sales. Second, it allows to monitor at the same time the impact of shocks on individual or groups of financial institutions as well as their vulnerability to shocks on counterparties or certain asset classes. Third, it includes estimates for loss distributions, thus combining network effects with familiar risk measures such as VaR and CVaR. Fourth, in order to perform robustness analyses and cope with incomplete data, the framework features a module for the generation of sets of networks of interbank exposures that are coherent with the total lending and borrowing of each bank. As an illustration, we carry out a stress--test exercise on a dataset of listed European banks over the years 2008-2013. We find that second-round and third-round effects dominate first-round effects, therefore suggesting that most current stress-test frameworks might lead to a severe underestimation of systemic risk. |
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Paolo Barucca, Marco Bardoscia, Fabio Caccioli, Marco D'Errico, Gabriele Visentin, Stefano Battiston, Guido Caldarelli, Network Valuation in Financial Systems, In: SSRN, No. 2795583, 2016. (Working Paper)
We introduce a network valuation model (hereafter NEVA) for the ex-ante valuation of claims among financial institutions connected in a network of liabilities. Similar to previous work, the new framework allows to endogenously determine the recovery rate on all claims upon the default of some institutions. In addition, it also allows to account for ex-ante uncertainty on the asset values, in particular the one arising when the valuation is carried out at some time before the maturity of the claims. The framework encompasses as special cases both the ex-post approaches of Eisenberg and Noe and its previous extensions, as well as the ex-ante approaches, in the sense that each of these models can be recovered exactly for special values of the parameters. We characterize the existence and uniqueness of the solutions of the valuation problem under general conditions on how the value of each claim depends on the equity of the counterparty. Further, we define an algorithm to carry out the network valuation and we provide sufficient conditions for convergence to the maximal solution. |
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Florin Onder, Different Forecasting Methodologies and their verification on a Stress Testing Model, University of Zurich, Faculty of Economics, Business Administration and Information Technology, 2016. (Bachelor's Thesis)
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Marco Bardoscia, Stefano Battiston, Fabio Caccioli, Guido Caldarelli, Pathways towards instability in financial networks, In: ArXiv.org, No. 1602.05883, 2016. (Working Paper)
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Tarik Roukny, Stefano Battiston, Joseph E Stiglitz, Interconnectedness as a source of uncertainty in systemic risk, In: SSRN, No. 2726631, 2016. (Working Paper)
Financial networks have shown to be important in understanding systemic events in credit markets. In this paper, we investigate how the structure of those networks can affect the capacity of regulators to assess the level of systemic risk. We introduce a model to compute the individual and systemic probability of default in a system of banks connected in a generic network of credit contracts and exposed to external shocks with a generic correlation structure. Even in the presence of complete knowledge, we identify conditions on the network for the emergence of multiple equilibria. Multiple equilibria give rise to uncertainty in the determination of the default probability. We show how this uncertainty can affect the estimation of systemic risk in terms of expected losses. We further quantify the effects of cyclicality, leverage, volatility and correlations. Our results are relevant to the current policy discussions on new regulatory framework to deal with systemic events of distress as well as on the desirable level of regulatory data disclosure. |
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Stefano Battiston, Antoine Mandel, Irene Monasterolo, Franziska Schuetze, Gabriele Visentin, A Climate Stress-Test of the EU Financial System, In: SSRN, No. 2726076, 2016. (Working Paper)
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