Financial network
A financial network is a concept describing any collection of financial entities (such as traders, firms, banks and financial exchanges) and the links between them, ideally through direct transactions or the ability to mediate a transaction.[1] A common example of a financial network link is security holdings (e.g. stock of publicly traded companies), where a firm’s ownership of stock would represent a link between the stock and the firm. In network science terms, financial networks are composed of financial nodes, where nodes represent financial institutions or participants, and of edges, where edges represent formal or informal relationships between nodes (i.e. stock or bond ownership).[2]
History
The concept and use of financial networks has emerged in response to the observation that modern financial systems exhibit a high degree of interdependence.[2] Globalization has magnified the level of financial interdependence across many kinds of organizations. Shares, assets, and financial relationships are held and engaged in at a greater degree over time. The trend is a topic of major interest in the financial sector, particularly due to its implications on financial crises.[3]
Crises have played a major role in developing the understanding of financial networks. In 1998, the crash of Long-Term Capital Management (LTCM) exposed their underlying importance. [4] In particular, the LTCM case highlighted the hidden correlations inherent in financial networks. In the case of LTCM, financial correlations were much higher than expected between Japanese bonds and Russian bonds. LTCM took on a significant amount of risk (at one point leveraged 25:1) to trade on this relationship, while underestimating these correlations. The 1997 Asian financial crisis and the subsequent 1998 Russian financial crisis lead to a divergence of European, Japanese and U.S. bonds, causing the collapse of LTCM. The ensuing crisis in the market proved the impact that financial networks can have.[5] Similarly, after the 2008 financial crisis, many economists have come around to the view the very architecture of the financial system plays a central role in shaping systemic risk. In fact, many of the ensuing policy actions have been motivated by these insights.[6] As a result, network science concepts have been cross-applied to the finance field.
Applications
Due to lack of data, current applications of financial networks are primarily confined to stock correlation networks, interbank networks, and agent-based models. Some agent based finance models which utilize a limit order book are instances of financial networks, where traders are connected to at least one exchange, and the exchange mediates transactions between traders.[7][8]
One primary area of study is cascades in financial networks, which helps scientists and policymakers determine how to mitigate financial crises.[9]
See also
References
- ^ Nagurney, A. and Ke, K. (2001). Financial networks with intermediation. Quantitative Finance (1): 441-451. doi:10.1088/1469-7688/1/4/304
- ^ a b Allen, Franklin (2008). "Networks in Finance" (PDF). Network-based Strategies and Competencies.
- ^ Elliott, Matthew (2014). "Financial Networks and Contagion" (PDF). American Economic Review.
- ^ Financial Networks - Statics and Dynamics | Anna Nagurney | Springer.
- ^ Lowenstein, Roger. When Genius Failed: The Rise and Fall of Long-Term Capital Management. New York: Random House, 2000. Print.
- ^ Acemoglu, Daron (2015). "Systemic Risk and Stability in Financial Networks". American Economic Review.
- ^ Bookstaber et al. (2014). An Agent-based Model for Financial Vulnerability. OFR Working Paper Series. Available at: http://www.treasury.gov/initiatives/ofr/research/Documents/OFRwp2014-05_BookstaberPaddrikTivnan_Agent-basedModelforFinancialVulnerability_revised.pdf
- ^ Tian Qiu et al 2010 New J. Phys. 12 043057 doi:10.1088/1367-2630/12/4/043057
- ^ Minoiu, Camelia Minoiu. "IMF Survey : Financial Networks Key to Understanding Systemic Risk." IMF Survey : Financial Networks Key to Understanding Systemic Risk. N.p., 28 May 2014. Web. 21 Nov. 2014.