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DebtRank: A microscopic foundation for shock propagation

Bardoscia, M; Battiston, S; Caccioli, F; Caldarelli, G; (2015) DebtRank: A microscopic foundation for shock propagation. PLoS ONE , 10 (6) , Article e0130406. 10.1371/journal.pone.0130406. Green open access

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The DebtRank algorithm has been increasingly investigated as a method to estimate the impact of shocks in financial networks, as it overcomes the limitations of the traditional default-cascade approaches. Here we formulate a dynamical "microscopic" theory of instability for financial networks by iterating balance sheet identities of individual banks and by assuming a simple rule for the transfer of shocks from borrowers to lenders. By doing so, we generalise the DebtRank formulation, both providing an interpretation of the effective dynamics in terms of basic accounting principles and preventing the underestimation of losses on certain network topologies. Depending on the structure of leverages the dynamics is either stable, in which case the asymptotic state can be computed analytically, or unstable, meaning that at least a bank will default. We apply this results to a network of roughly 200 among the largest European banks in the period 2008 - 2013. We show that network effects generate an amplification of exogenous shocks of a factor ranging between three (in normal periods) and six (during the crisis), when we stress the system with a 0.5% shock on external (i.e. non-interbank) assets for all banks.

Type: Article
Title: DebtRank: A microscopic foundation for shock propagation
Open access status: An open access version is available from UCL Discovery
DOI: 10.1371/journal.pone.0130406
Publisher version: http://dx.doi.org/10.1371/journal.pone.0130406
Language: English
Additional information: © 2015 Bardoscia et al. This is an open access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited
Keywords: q-fin.RM, q-fin.RM, Eigenvalues, Algorithms, Financial markets, Graphs, System instability, Complex systems, Stock markets, Structure of markets
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL BEAMS
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science > Dept of Computer Science
URI: https://discovery.ucl.ac.uk/id/eprint/1466612
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