Ecosystems perspective on financial networks: diagnostic tools

TL;DR

This paper introduces network analysis tools to diagnose the health of financial systems, revealing that clustering and reduced diversity can signal systemic risks and past crises.

Contribution

It develops novel temporal and structural network tools to analyze economic interconnectedness and identify warning signs of instability.

Findings

Strong clustering can indicate systemic risk.

Reduction in diversity correlates with financial crises.

Detection of anomalous firm clusters in real-world data.

Abstract

The economical world consists of a highly interconnected and interdependent network of firms. Here we develop temporal and structural network tools to analyze the state of the economy. Our analysis indicates that a strong clustering can be a warning sign. Reduction in diversity, which was an essential aspect of the dynamics surrounding the crash in 2008, is seen as a key emergent feature arising naturally from the evolutionary and adaptive dynamics inherent to the financial markets. Similarly, collusion amongst construction firms in a number of regions in Japan in the 2000s can be identified with the formation of clusters of anomalous highly connected companies.