Partially Overlapping Ownership and Contagion in Financial Networks

Complexity, Nov 2017

Using historical banking data for the United States from the years 2000 to 2015 we characterize the probability and extent of a financial contagion using a calibrated network model of heterogeneous interbank exposures. Both the probability and the average extent of a contagion begin to rise in 2007 prior to the US financial crisis. Including a common asset in the model increases both the probability and extent of contagion, especially during the years of the financial crisis. Based on rising institutional ownership in the banking industry, we introduce a partially overlapping ownership asset that devalues endogenously. The addition of this asset increases the extent of a financial contagion. Our results show that trends in capital buffers and the distribution and type of assets have a significant effect on the predictions of financial network contagion models and that the rising trend in ownership of banks by banks amplifies shocks to the financial system.

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Partially Overlapping Ownership and Contagion in Financial Networks

Partially Overlapping Ownership and Contagion in Financial Networks Micah Pollak1 and Yuanying Guan2 1School of Business and Economics, Indiana University Northwest, 3400 Broadway, Gary, IN 46408, USA 2Department of Mathematics and Actuarial Science, Indiana University Northwest, 3400 Broadway, Gary, IN 46408, USA Correspondence should be addressed to Micah Pollak; ude.nui@kallopm Received 27 July 2017; Accepted 8 October 2017; Published 6 November 2017 Academic Editor: Ahmet Sensoy Copyright © 2017 Micah Pollak and Yuanying Guan. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. Abstract Using historical banking data for the United States from the years 2000 to 2015 we characterize the probability and extent of a financial contagion using a calibrated network model of heterogeneous interbank exposures. Both the probability and the average extent of a contagion begin to rise in 2007 prior to the US financial crisis. Including a common asset in the model increases both the probability and extent of contagion, especially during the years of the financial crisis. Based on rising institutional ownership in the banking industry, we introduce a partially overlapping ownership asset that devalues endogenously. The addition of this asset increases the extent of a financial contagion. Our results show that trends in capital buffers and the distribution and type of assets have a significant effect on the predictions of financial network contagion models and that the rising trend in ownership of banks by banks amplifies shocks to the financial system. 1. Introduction Following the 2008-2009 US and global financial crisis, there has been a growing interest in the role that the network structure of banks and the types and distribution of their assets have in determining the probability and extent of a potential financial contagion. Chinazzi and Fagiolo [1] provide a concise survey of recent literature in this area. Two limitations common in much of this research relate to the complexity of the network and asset structure and the availability of data. First, the assets and network structures observed in real world financial systems tend to be more complicated than assumed in typical financial network models. Second, detailed data on the structure of real world financial networks is often extremely limited, especially for a major nation like the United States. Empirical papers tend to focus on nations other than the US and often employ data from a single or small number of years. In this paper we improve on these two limitations. First, in addition to the standard assumption of direct exposures (interbank loans) and independent external assets, we add an external common asset (similar to [2]) and we introduce the concept of a partially overlapping ownership asset, or an asset held by some banks that has value endogenously determined by failures within the banking industry (i.e., such as an investment in an indexed portfolio of stock for the banking industry). In addition to these assets, we consider a core-periphery network structure, which is increasingly becoming the preferred representation of the banking industry. We contrast our results with those from a scale-free network, which is another common network structure. Finally, we use historical financial information for depository institutions in the United States, for the years prior to and following the financial crisis, to calibrate key financial network characteristics such as the size of the network, total assets, and capital buffers for individual banks as well as to characterize and distribute the partially overlapping ownership asset. These steps allow us to investigate how the predictions of a financial contagion model change based on observed trends in the banking industry. Equity ownership of banks by banks is becoming increasingly common in the United States. Between 2000 and 2015 the number of banks with ownership in other banks doubled in the United States. Over the same time, the total value of this ownership across the banking system has been growing, especially following the financial crisis. Between 2011 and 2015 the total value of ownership of banks by banks increased by 211% (over this same time period the value of the S&P 500 rose by 55%). This growth in bank ownership by banks has the potential to add a new and significant feedback channel that amplifies shocks. For example, a negative shock to the banking industry reduces the value of ownership in banks, which, in turn, further negatively affects balance sheets of banks, further reducing the value of bank ownership and adding additional stress to the system. To investigate this trend in institutional ownership, we introduce a partially overlapping ownership asset, to capture the rise in equity ownership of banks by banks, an (...truncated)


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Micah Pollak, Yuanying Guan. Partially Overlapping Ownership and Contagion in Financial Networks, Complexity, 2017, 2017, DOI: 10.1155/2017/9895632