This was part of Systemic Risk and Stress Testing

Fire Sales and Default Cascades in Complex Financial Networks

Hamed Amini, Georgia State University

Thursday, April 7, 2022

Abstract: In this talk, we study two channels of loss amplification in the financial system. In the first part, we model the propagation of balance-sheet or cash-flow insolvency across financial institutions as a cascade process on a network representing their mutual exposures. We derive rigorous asymptotic results for the magnitude of contagion in a large financial network and give an analytical expression for the asymptotic fraction of defaults, in terms of network characteristics. We also introduce a criterion for the resilience of a large inhomogeneous financial network to initial shocks. We next present a general tractable framework for understanding the joint impact of fire sales and insolvency cascades on systemic risk in financial networks. Our limit theorems quantify how price mediated contagion across institutions with common asset holding could worsen cascades of insolvencies in a heterogeneous financial network. Our numerical studies investigate the effect of heterogeneity in network structure and price impact function on the final size of default cascade and fire sales loss. The talk is based on joint works with Zhongyuan Cao, Rama Cont, Andreea Minca and Agnès Sulem.