Matching and Resilience in Financial Networks

Leduc MV & Thurner S (2016). Matching and Resilience in Financial Networks. In: 7th Annual Financial Market Liquidity Conference, 17-18 November 2016, Budapest, Hungary.

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Abstract

When banks extend loans to each other, they generate a negative externality in the form of systemic risk. They create a network of interbank exposures by which they expose other banks to potential insolvency cascades. In this paper, we show how a regulator can use information ab out the financial network to devise a transaction-specific tax based on a network centrality measure that captures systemic importance. Since different transactions have different impact on creating systemic risk, they are taxed differently. We call this tax a Systemic Risk Tax (SRT). We show that this SRT induces a unique equilibrium matching of lenders and borrowers that is systemic-risk efficient, i.e. it minimizes systemic risk given a certain transaction volume. On the other hand, we show that without this SRT multiple equilibrium matchings can exist and are generally inefficient. This allows the regulator to effectively `rewire' the equilibrium interbank network so as to make it more resilient to insolvency cascades, without sacrificing transaction volume. Moreover, we show that a standard financial transaction tax (e.g. a Tobin-like tax) has no impact on reshaping the equilibrium financial network because it taxes all transactions indiscriminately. A Tobin-like tax is indeed shown to have a limited effect on reducing systemic risk while it decreases transaction volume.

Item Type: Conference or Workshop Item (Paper)
Research Programs: Advanced Systems Analysis (ASA)
Depositing User: Luke Kirwan
Date Deposited: 07 Dec 2016 09:16
Last Modified: 07 Dec 2016 09:16
URI: http://pure.iiasa.ac.at/14094

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