Financial interconnectedness gives rise to systemic risk via - PowerPoint PPT Presentation

Financial interconnectedness gives rise to systemic risk via financial contagion 1

Recent policy to reduce interconnectedness: eliminate cycles = Portfolio Compression 𝑑 = (𝐵– 𝐶– 𝐷, 1) B B 1 A A 2 1 3 2 C C 2

Research Question: Systemic effects of portfolio compression Research Questions: Given a specific compression: 1. When socially beneficial? 2. Banks’ incentives to agree to it? Conventional wisdom: 1. always, 2. always 3

Portfolio Compression in Financial Networks: Incentives and Systemic Risk Steffen Schuldenzucker 1 and Sven Seuken 2 1 Algorithms and Complexity Research Group, Goethe University Frankfurt 2 Computation and Economics Research Group, University of Zurich Results: • Conventional wisdom is wrong → Non-trivial trade-off: loss sharing vs. contagion • Sufficient conditions: Pareto improvement (bank balance sheets, network structure) • Sufficient conditions: Incentivized compression (network structure)