Portfolio Homogenization and Systemic Risk of Financial Network

Huang, Yajing and Liu, Taoxiong and Lien, Donald (2017): Portfolio Homogenization and Systemic Risk of Financial Network.

Abstract

In this paper, we argue that systemic risk should be understood from two different perspectives, the homogeneity of portfolios (or called asset homogeneity) and the contagion mechanism. The homogenization of portfolios held by different financial institutions increases the positive correlations among them and therefore the probability of simultaneous collapses of a considerable part of the network, which are prerequisites and amplifiers of contagion. We first theoretically analyze the influence of asset homogeneity on the initial risk, fragility and systemic risk of the network. Based on the theoretical predictions, we perform simulations on regular networks and Poisson random networks to illustrate the effects of portfolio homogeneity on systemic risk. It is shown that the relationship between asset homogeneity and systemic risk is not always positively related. When the network contagion is weak, then a high asset homogeneity will lead to a high systemic risk. However, if the network contagion is considerably strong, the systemic risk is quite likely to be negative related to the asset homogeneity, so that a high homogeneity will produce a low systemic risk. Moreover, networks with strong contagion and low asset homogeneity tend to have the greatest systemic risk. Results from logistic regression analysis further clarify the relationships between systemic risk and asset homogeneity.

• Item Type: MPRA Paper
• Language: English
• Keywords: Financial network; Portfolio homogenization; Contagion; Systemic risk
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D85 - Network Formation and Analysis: Theory; F - International Economics > F6 - Economic Impacts of Globalization > F65 - Finance; G - Financial Economics > G0 - General > G01 - Financial Crises; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation

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