Network models of financial systemic risk: A review

TL;DR

This review discusses recent advances in modeling financial systemic risk using network science, highlighting how interconnected financial institutions can propagate risk and cause systemic failures.

Contribution

It provides a comprehensive overview of network-based models of financial risk and summarizes empirical findings on interbank network structures.

Findings

Network models help understand risk propagation mechanisms.

Empirical interbank networks exhibit complex structural properties.

Recent models identify key factors influencing systemic stability.

Abstract

The global financial system can be represented as a large complex network in which banks, hedge funds and other financial institutions are interconnected to each other through visible and invisible financial linkages. Recently, a lot of attention has been paid to the understanding of the mechanisms that can lead to a breakdown of this network. This can happen when the existing financial links turn from being a means of risk diversification to channels for the propagation of risk across financial institutions. In this review article, we summarize recent developments in the modeling of financial systemic risk. We focus in particular on network approaches, such as models of default cascades due to bilateral exposures or to overlapping portfolios, and we also report on recent findings on the empirical structure of interbank networks. The current review provides a landscape of the newly arising interdisciplinary field lying at the intersection of several disciplines, such as network science, physics, engineering, economics, and ecology.