Related papers: How dark is the dark side of diversification?
Risk diversification is the basis of insurance and investment. It is thus crucial to study the effects that could limit it. One of them is the existence of systemic risk that affects all the policies at the same time. We introduce here a…
The question of how to stabilize financial systems has attracted considerable attention since the global financial crisis of 2007-2009. Recently, Beale et al. ("Individual versus systemic risk and the regulator's dilemma", Proc Natl Acad…
We consider the problem of risk diversification in complex networks. Nodes represent e.g. financial actors, whereas weighted links represent e.g. financial obligations (credits/debts). Each node has a risk to fail because of losses…
Excessive leverage, i.e. the abuse of debt financing, is considered one of the primary factors in the default of financial institutions. Systemic risk results from correlations between individual default probabilities that cannot be…
Portfolio diversification is a cornerstone of modern finance, while risk aversion is central to decision theory; both concepts are long-standing and foundational. We investigate their connections by studying how different forms of…
Foreign exchange and credit derivatives increase the bank's contributions to systemic risk. Interest rate derivatives decrease it. The proportion of non-performing loans over total loans and the leverage ratio have stronger impact on…
The instability of the financial system as experienced in recent years and in previous periods is often linked to credit defaults, i.e., to the failure of obligors to make promised payments. Given the large number of credit contracts, this…
Network theory proved recently to be useful in the quantification of many properties of financial systems. The analysis of the structure of investment portfolios is a major application since their eventual correlation and overlap impact the…
The fragility of financial systems was starkly demonstrated in early 2023 through a cascade of major bank failures in the United States, including the second, third, and fourth largest collapses in the US history. The highly interdependent…
Shaped by structural forces of change, banking in emerging markets has recently experienced a decline in its traditional activities, leading banks to diversify into new business strategies. This paper examines whether the observed shift…
We propose a definition of diversification as a binary relationship between financial portfolios. According to it, a convex linear combination of several risk positions with some weights is considered to be less risky than the probabilistic…
Systemic financial risk refers to the simultaneous failure or destabilization of multiple financial institutions, often triggered by contagion mechanisms or common exposures to shocks. In this paper, we present a dynamical model of bank…
Diversification represents the idea of choosing variety over uniformity. Within the theory of choice, desirability of diversification is axiomatized as preference for a convex combination of choices that are equivalently ranked. This…
The interconnectedness of financial institutions affects instability and credit crises. To quantify systemic risk we introduce here the PD model, a dynamic model that combines credit risk techniques with a contagion mechanism on the network…
Common asset holdings are widely believed to have been the primary vector of contagion in the recent financial crisis. We develop a network approach to the amplification of financial contagion due to the combination of overlapping…
We study how to assess the potential benefit of diversifying an equity portfolio by investing within and across equity sectors. We analyse 20 years of US stock price data, which includes the global financial crisis (GFC) and the COVID-19…
Value at risk (VaR) is a risk measure that has been widely implemented by financial institutions. This paper measures the correlation among asset price changes implied from VaR calculation. Empirical results using US and UK equity indexes…
It had been believed in the conventional practice that the risk of a bank going bankrupt is lessened in a straightforward manner by transferring the risk of loan defaults. But the failure of American International Group in 2008 posed a more…
Evaluation of systemic risk in networks of financial institutions in general requires information of inter-institution financial exposures. In the framework of Debt Rank algorithm, we introduce an approximate method of systemic risk…
This paper investigates two mechanisms of financial contagion that are, firstly, the correlated exposure of banks to the same source of risk, and secondly the direct exposure of banks in the interbank market. It will consider a random…