An optimization model for minimizing systemic risk
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An optimization model for minimizing systemic risk Rosella Castellano1
· Roy Cerqueti2,3 · Gian Paolo Clemente4 · Rosanna Grassi5
Received: 22 May 2019 / Accepted: 24 August 2020 © Springer-Verlag GmbH Germany, part of Springer Nature 2020
Abstract This paper proposes an optimal allocation model with the main aim to minimize systemic risk related to the sovereign risk of a set of countries. The reference methodological environment is that of complex networks theory. Specifically, we consider the weighted clustering coefficient as a proxy of systemic risk, while the interconnections among countries are captured by the relationships among default probabilities of the set of countries under consideration. The selected optimization criterion is based on minimization of the mean absolute deviation. We perform empirical analyses to validate the theoretical predictions, and interpret the findings in the context of the proposed model. Keywords Systemic risk · Complex networks · Clustering coefficient · Credit default swaps · Mean absolute deviation · Optimization JEL Classification G01 · G10 · C61 · C63
1 Introduction Since the beginning of the 2008 financial crisis, the price of credit protection in the Euro area has substantially increased as systemic risks have grown more prominent. In late September
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Rosella Castellano [email protected] Roy Cerqueti [email protected]; [email protected] Gian Paolo Clemente [email protected] Rosanna Grassi [email protected]
1
Department of Law and Economics, University of Rome UnitelmaSapienza, Rome, Italy
2
Department of Social and Economic Sciences, Sapienza University of Rome, Rome, Italy
3
School of Business, London South Bank University, London, UK
4
Department of Mathematics for economic, financial and actuarial Sciences, Universitá Cattolica del Sacro Cuore, Milan, Italy
5
Department of Statistics and Quantitative Methods, University of Milano-Bicocca, Milan, Italy
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Mathematics and Financial Economics
2008, the sovereign credit default swap (CDS) market attracted considerable attention, which peaked in flight to safety episodes in May 2010 [4]. Sovereign debt markets in several countries came under stress, and massive sell-offs in government bonds were observed. High CDS quotes during that period were interpreted as falling market liquidity and also as concerns about an increasing number of credit rating downgrades. In other words, since the sovereign Euro crisis, CDS spreads have been considered as warning signaling tools that may increase the perception of government credit riskiness and, consequently, the systemic risk. In this context, the concept of systemic risk refers to the possibility that a collapse of one of the components of a complex system leads to the instability or breakdown of the entire system. Financial systems are often highly interconnected, and such interconnections contribute to risk spreading. The possibility of cascading failures, that is the default of one financial agent might trigg
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