The price of complexity in financial networks

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 erro...

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Bibliographic Details
Published in:Proceedings of the National Academy of Sciences - PNAS 2016-09, Vol.113 (36), p.10031-10036
Main Authors: Battiston, Stefano, Caldarelli, Guido, May, Robert M., Roukny, Tarik, Stiglitz, Joseph E.
Format: Article
Language:English
Subjects:
Errors
Financial institutions
Knowledge
Physical Sciences
Probability
Social Sciences
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Summary: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.
ISSN:0027-8424
1091-6490
DOI:10.1073/pnas.1521573113