Project

Back to overview

OTC Derivatives and Systemic Risk in Financial Networks

English title OTC Derivatives and Systemic Risk in Financial Networks
Applicant Schweitzer Frank
Number 127000
Funding scheme Interdisciplinary projects
Research institution Departement Management, Technologie und Ökonomie D-MTEC ETH Zürich
Institution of higher education ETH Zurich - ETHZ
Main discipline Economics
Start/End 01.08.2010 - 30.09.2013
Approved amount 476'277.00
Show all

All Disciplines (4)

Discipline
Economics
Science of management
Other disciplines of Physics
Condensed Matter Physics

Keywords (8)

systemic risk; derivatives; financial networks; complex networks; financial markets; financial instability; financial network; regulation

Lay Summary (English)

Lead
Lay summary
The volume of OTC (over-the-counter) markets represents an important part of the total value of financial markets. Different from regulated markets, OTC markets are non-regulated markets, in which derivatives on different underlying assets are traded without the presence of a clearing house. That means the counterpart default risk generates a network of interdependences among actors. In this project, we investigate how the structure of financial networks affects systemic risk, and in particular to what extent OTC derivatives contribute to systemic risk.Our insights shall clarify the impact of derivatives on financial instability. On one hand, derivative products make market more complete and thus are claimed to improve stability. On the other hand, derivatives are suspected to increase the probability of financial instability due to various reasons (e.g. complexity, lack of transparency, disproportionate leverage, etc.). To gain more insight into this, the project consists of a theoretical part and an empirical one. The first one aims at bridging two existing strands of literature: one, in finance, on default correlation and another one, in economics, on systemic risk in credit networks. The empirical part of the project analyzes cross-sectional time series of financial statements data, including off-balance exposures mainly represented by OTC derivatives. This helps to identify two fundamental mechanisms in propagating financial distress among agents, namely the interdependence of their financial robustness and the trend reinforcement, known as financial acceleration.The project is novel and challenging as it combines previously unconnected research strands in financial economics and network theory. By merging these, we hope to achieve a better understanding of the relation between integration of financial markets and financial instability.
Direct link to Lay Summary Last update: 21.02.2013

Responsible applicant and co-applicants

Employees

Publications

Publication
Credit default swaps drawup networks: Too interconnected to be stable?
Kaushik Rahul, Battiston Stefano (2013), Credit default swaps drawup networks: Too interconnected to be stable?, in PLoS ONE, 8(7), e61815.
DebtRank: Too Central to Fail? Financial Networks, the FED and Systemic Risk
Battiston Stefano, Puliga Michelangelo, Kaushik Rahul, Tasca Paolo, Caldarelli Guido (2012), DebtRank: Too Central to Fail? Financial Networks, the FED and Systemic Risk, in Scientific Reports 2, 541-541.

Collaboration

Group / person Country
Types of collaboration
Universität Zürich Switzerland (Europe)
- Publication
IMT Lucca Italy (Europe)
- Publication

Scientific events

Active participation

Title Type of contribution Title of article or contribution Date Place Persons involved
Seminar - Central Bank of Austria Talk given at a conference DeptRank: Too Central to Fail? 21.07.2013 Wien, Austria Battiston Stefano;
Stat Phys Satellite Workshop, Financial Networks and Systemic Risk Talk given at a conference DebtRank Analysis of Japanese Credit Network 17.07.2013 Kyoto, Japan Battiston Stefano;
Horizons in Social Sciences 2013 Talk given at a conference DebtRank, Systemic Risk and Future Challenges for the Social Scieces 11.07.2013 Lucca, Italy Battiston Stefano;
he International Workshop and Conference on Network Science (NetSci) Talk given at a conference Introduction to Parallel Session on Financial Networks: Overview of FOC Activities 06.06.2013 Kopenhagen, Denmark Battiston Stefano;
Workshop on Complexity Models for Systemic Instabilities and Crises Talk given at a conference Modeling Systemic Risk 09.04.2013 Leiden, Netherlands Schweitzer Frank;
DebtRank: Too Central to Fail? Financial Networks, the FED and Systemic Risk Talk given at a conference 6th Annual Quant Invest Congress 06.11.2012 Paris, France Battiston Stefano;
Workshop on the Crisis of Financialized Capital Talk given at a conference The architecture of the global corporate control network 24.10.2012 Toulouse, France Battiston Stefano;
Workshop on Global Systems and Networks of Networks Talk given at a conference DebtRank: Too Central to Fail? Financial Networks, the FED and Systemic Risk 27.09.2012 Madrid, Spain Battiston Stefano;
2013 Chinese Conference 'Complex Networks' Talk given at a conference Success and Failure: A Complex Network Approach 13.09.2012 Hangzhou, China Schweitzer Frank;
Latsis Symposium Talk given at a conference The Matrix of Market Procyclicality and Systemic Risk 11.09.2012 Zürich, Switzerland Battiston Stefano;
COST MP0801 Annual Meeting Talk given at a conference Systemic Risk in Economic and Financial Networks 11.07.2012 Galway, Ireland Schweitzer Frank;
Risk Center Seminar Series Talk given at a conference Systemic risk 24.04.2012 Zürich, Switzerland Schweitzer Frank;
ECARES, Université Libre de Bruxelles Talk given at a conference Emergence of Systemic Risk in Financial Networks 09.02.2012 Brussels, Belgium Battiston Stefano;
Risk Center Seminar Series Talk given at a conference Systemic risk in financial networks 29.11.2011 Zürich, Switzerland Battiston Stefano;


Self-organised

Title Date Place
Latsis Symposium: Economics on the move 12.09.2012 Zürich, Switzerland
Satellite Workshop 11.09.2012 Zürich, Switzerland

Knowledge transfer events

Active participation

Title Type of contribution Date Place Persons involved
Internal Seminar at Central Bank of Portugal: Systemic risk in financial networks 30.03.2013 Lisbon, Portugal Tasca Paolo;
Deutsche Bundesbank Conference NetoNet 13.02.2013 Frankfurt, Germany Battiston Stefano;


Communication with the public

Communication Title Media Place Year
Media relations: print media, online media DebtRank: Too Central to Fail? Financial Networks, the FED and Systemic Risk NewScientist International 2012

Associated projects

Number Title Start Funding scheme
172890 Financial Networks and Systemic Risk - Extension 01.11.2017 SNSF Professorships
144689 Financial Networks and Systemic Risk 01.11.2013 SNSF Professorships

Abstract

The volume of non-regulated (OTC) markets represents an important part ofthe total value of financial markets. In these markets, the counterpartdefault risk generates a network of ties of interdependence amongactors. This project will investigate how the structureof financial networks affects systemic risk, and in particular to what extentOTC derivatives contribute to systemic risk.The work aims at contributing to the debate on the respective role of theso called financial deepening in the onset of financial instability. Inthis context, we start from the identification of two fundamentalmechanisms at work in the propagation of financial distress among agents,namely the interdependence of their financial robustness and the trend reinforcement.The project consists of a theoretical part and an empirical one. Thetheoretical part aims at bridging two existing strands of literature:one, in finance, on default correlation and another one, in economics, onsystemic risk in credit networks. In this we build on our recent and on-goingwork on systemic risk in credit networks. We further develop a model thatdynamically describes the evolution of financial robustness at a firm-levelwhen agents are connected in a network of credit and OTC derivativecontracts.The empirical part of the project analyses cross-sectional time series offinancial statements data, including off-balance exposures mainlyrepresented by OTC derivatives. Besides the classical horizontal andvertical analysis of balance sheets and profit-loss accounts, the ratiosand cash-flows analysis, we are interested in detecting the presence ofthe mechanisms of interdependence and trend reinforcement in order topossibly validate the models developed in the theoretical part.Since our previous work has shown that credit networks can becomeunstable if agents are too much interconnected, a crucial point (relatedto important monetary policy issues) is to introduce OTC derivativecontracts to better fit the realm of financial markets and thusinvestigate their impact on stability.
-