What Financial Regulators Can Learn from Network Theory

When regulators seek to identify systemically important financial institutions (SIFIs), they tend to focus on an institution’s size and connectedness. But this approach mises an important dimension of systemic risk, according to Imre Kondor, Stefano Battiston, Giorgio Fagiolo, and Alan Kirman.

This team of economists and physicists emphasizes that systemic risk is a complex and collective problem, not something that can be read off the balance sheet of individual units. They take into account all kinds of indirect influences – managers in business schools and quants at trading desks comprise a social network whose members consume more of less the same information – to investigate how strong correlations can arise between seemingly unrelated institutions at dispersed areas of a network. Strongly correlated clusters of institutions, they say, are what regulators need to watch out for.

Comments

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This is a very interesting line of thoughts…my problem though is that there are three of them, because that makes them, albeit small, into a de-facto net-work, and so, de facto, it could also turn them into a very small mutual admiration club, something which effectively puts a lid on what they can produce.

For instance, it is amazing how we correctly want to assure the existence of independent central bankers, but then do not worry at all about how independent our central bankers really are.

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RE: Strongly correlated clusters of institutions, they say, are what regulators need to watch out for.

Yes; a couple of years ago I proposed a countervailing solution called a virtual interactive think tank for macro prudential regulation, a kind of Internet supported "college of wise and connected" that would have the comprehensiveness and depth of understanding needed to understand and counter those risks.

Val Samonis
Toronto

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Yes, Network Theory, and similiar notions concerned with complexity are fine as far as they go.However, what if it were actually possible to continually monitor the economy in real-time? Could this not give a far more accurate understanding as to the actual mechanics of economics itself? This is explained in my evolving project of Transfinancial Economics found at the p2p foundation. Moreover, a degree of commercial confidentiality could also be respected.

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Network cloud is a type of computing that relies on sharing computing resources rather than having local servers or personal devices to handle applications.

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