The Physics of Financial Networks

TL;DR

This paper reviews how statistical physics and complex network theory are applied to analyze the structure, dynamics, and systemic risk of financial networks, highlighting recent theoretical and practical advancements.

Contribution

It provides a comprehensive overview of the definitions, dynamics, and applications of financial networks, integrating recent theoretical developments like DebtRank and multiplex representations.

Findings

Financial networks are crucial for systemic risk analysis.

DebtRank effectively measures shock impact and diffusion.

Complex network tools aid in financial stability and climate finance analysis.

Abstract

The field of Financial Networks is a paramount example of the novel applications of Statistical Physics that have made possible by the present data revolution. As the total value of the global financial market has vastly outgrown the value of the real economy, financial institutions on this planet have created a web of interactions whose size and topology calls for a quantitative analysis by means of Complex Networks. Financial Networks are not only a playground for the use of basic tools of statistical physics as ensemble representation and entropy maximization; rather, their particular dynamics and evolution triggered theoretical advancements as the definition of DebtRank to measure the impact and diffusion of shocks in the whole systems. In this review we present the state of the art in this field, starting from the different definitions of financial networks (based either on loans, on assets ownership, on contracts involving several parties -- such as credit default swaps, to multiplex representation when firms are introduced in the game and a link with real economy is drawn) and then discussing the various dynamics of financial contagion as well as applications in financial network inference and validation. We believe that this analysis is particularly timely since financial stability as well as recent innovations in climate finance, once properly analysed and understood in terms of complex network theory, can play a pivotal role in the transformation of our society towards a more sustainable world.