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The Journal of Alternative Investments

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DebtRank and the Network of Leverage

Stefano Battiston, Marco D’Errico and Stefano Gurciullo
The Journal of Alternative Investments Spring 2016, 18 (4) 68-81; DOI: https://doi.org/10.3905/jai.2016.18.4.068
Stefano Battiston
is a professor in the Department of Banking and Finance at the University of Zurich in Zurich, Switzerland.
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  • For correspondence: stefano.battiston@uzh.ch
Marco D’Errico
is a postdoctoral researcher in the Department of Banking and Finance at the University of Zurich in Zurich, Switzerland.
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  • For correspondence: marco.derrico@uzh.ch
Stefano Gurciullo
is a doctoral candidate in the School of Public Policy at University College London in London, U.K.
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  • For correspondence: stefano.gurciullo.11@ucl.ac.uk
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Abstract

The interconnectedness of the financial system is one of the main factors contributing to systemic risk. The financial crisis has shown how the network of intrafinancial exposures may, in times of systemic distress, amplify initially small shocks. In this work, the authors build on the DebtRank methodology by introducing the notion of a network of leverage and propose a two-round stress test exercise. In the first round, a shock hits banks’ external assets; in the second round, these initial losses reverberate in the network of interbank exposures because of the devaluation of interbank obligations. Losses in the second round result from a multiplicative effect between external and interbank leverage. The authors then apply the stress test to the largest EU banks for the years 2008–2013. They find that second-round losses are at least as large as first-round losses; neglecting these effects could therefore lead to a severe underestimation of systemic risk.

TOPICS: Financial crises and financial market history, risk management, exchanges/markets/clearinghouses, developed

  • © 2016 Pageant Media Ltd
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The Journal of Alternative Investments: 18 (4)
The Journal of Alternative Investments
Vol. 18, Issue 4
Spring 2016
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DebtRank and the Network of Leverage
Stefano Battiston, Marco D’Errico, Stefano Gurciullo
The Journal of Alternative Investments Mar 2016, 18 (4) 68-81; DOI: 10.3905/jai.2016.18.4.068

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DebtRank and the Network of Leverage
Stefano Battiston, Marco D’Errico, Stefano Gurciullo
The Journal of Alternative Investments Mar 2016, 18 (4) 68-81; DOI: 10.3905/jai.2016.18.4.068
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    • NETWORKS OF LEVERAGE
    • RESULTS AND DISCUSSION
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