Networks of Economic Market Interdependence and Systemic Risk

TL;DR

This paper analyzes how the evolving network of inter-sector correlations in markets influences systemic risk, highlighting the role of financial sector links in cascading failures and proposing firewalls to mitigate risks.

Contribution

It introduces a dynamic network analysis of market sector correlations, revealing how financial links increase systemic risk and suggesting risk mitigation strategies.

Findings

Financial sector links strengthen during economic declines.

Correlations among sectors increase during market downturns.

Implementing firewalls could reduce systemic risk.

Abstract

The dynamic network of relationships among corporations underlies cascading economic failures including the current economic crisis, and can be inferred from correlations in market value fluctuations. We analyze the time dependence of the network of correlations to reveal the changing relationships among the financial, technology, and basic materials sectors with rising and falling markets and resource constraints. The financial sector links otherwise weakly coupled economic sectors, particularly during economic declines. Such links increase economic risk and the extent of cascading failures. Our results suggest that firewalls between financial services for different sectors would reduce systemic risk without hampering economic growth.