Matrix Metrics: Network-Based Systemic Risk Scoring

Abstract

The author proposes a novel framework for network-based systemic risk measurement and management. He defines a new systemic risk score that depends on the level of individual risk at each financial institution and the interconnectedness across institutions; this score is generally applicable irrespective of how interconnectedness is defined. This risk metric is decomposable into risk contributions from each entity, forming a basis for taxing each entity appropriately. The authors shows that we may calculate risk increments to assess the potential risk of each entity on the overall financial system. The article develops other subsidiary risk measures, such as system fragility and entity criticality. An assessment using a measure of spillover risk is obtained to determine the scale of externalities that one bank might impose on the system; the metric is robust to this cross-risk and does not induce predatory spillovers. The analysis in this article suggests that splitting up too-big-to-fail banks does not lower systemic risk.