The risk of contagion spreading and its optimal control in the economy

TL;DR

This paper models the spread of financial contagion using epidemiological methods, analyzing its dynamics in the global banking network and proposing optimal control strategies to mitigate systemic risks.

Contribution

It introduces a novel application of epidemiological models to financial contagion and formulates an optimal control problem for preventing systemic financial crises.

Findings

Contagion spread resembles disease transmission in epidemiology.

International relations significantly influence financial stability.

Optimal control can effectively reduce systemic risk.

Abstract

The global crisis of 2008 provoked a heightened interest among scientists to study the phenomenon, its propagation and negative consequences. The process of modelling the spread of a virus is commonly used in epidemiology. Conceptually, the spread of a disease among a population is similar to the contagion process in economy. This similarity allows considering the contagion in the world financial system using the same mathematical model of infection spread that is often used in epidemiology. Our research focuses on the dynamic behaviour of contagion spreading in the global financial network. The effect of infection by a systemic spread of risks in the network of national banking systems of countries is tested. An optimal control problem is then formulated to simulate a control that may avoid significant financial losses. The results show that the proposed approach describes well the reality of the world economy, and emphasizes the importance of international relations between countries on the financial stability.