EAGER: Modeling systemic risk: Finding precursors of emerging financial crises

Trustees Of Boston University, Boston

Investigators

Abstract

In our modern world, the critical infrastructure systems like electric power, water supply telecommunications and banking and finance that affect all areas of daily life are usually interdependent. Even though systemic risk is not unique to markets and financial institutions, the far-reaching consequences from the failure of a financial institution are in general much more significant than the impact of the demise of a non-financial institution. The failure of individual companies within a particular industry will not propagate throughout the corporate system, but the failure of a one large bank can bring the economy to the brink of disaster. This proposal will use tolls from economics, physics, computer science and statistics to build a model that will monitor financial systems and develop an early warning system for impending financial crises. The goal of this project is to use concepts from complexity science and interdependent network theory to create a signaling mechanism for potential financial crisis cascades based on the complex interdependencies of different economic and financial networks. The research will demonstrate short-range and long-range correlations in interacting networks and identify and describe the dependencies of different financial networks as a complex system. It will model the cascading effect of a crisis using dependency links that connect the failure of one network node to the failure of another network node. The proposal will combine information from bank analysis, investor sentiments, sovereign debt and regulatory frameworks to create monitoring system and a potential early warning for the global financial system.