Investment Diversification And Systemic Risk In Banking Based On Network Theory

In recent years,financial crises have occurred from time to time with the deepening development of global financial markets.Therefore,the systemic risk of financial markets has been paid more attentions gradually.The financial market in China gets off the ground later than developed countries,so that risk control experiences and financial supervision measures are far from sufficient.Besides,we confront a more complex environment in the era of deepening reform and gradual opening up.Therefore,it is particularly necessary to strictly control systemic risks.According to the actual demand,all banks will diversify their investments to reduce individual risks.However,diversification of investments will increase the holding of common assets,thus providing more indirect channels for contagion risks.Therefore,diversification of investments will inevitably have an important impact on systemic risks.References have not yet reached a clear conclusion on the relationship between investment diversification and systemic risk.Moreover,the impact of interbank loans is not considered.Based on the above considerations,this paper describes the interbank loans from the perspective of network theory,and further studies the relationship between diversification of investments and systemic risk.Firstly,the differences and connections between individual risk and systemic risk are discussed by simplified mathematical models.The effects of interbank loans and fire sales of assets on systemic risk are also demonstrated.On the basis of above works,the relationship between diversification of investments and systemic risk is further studied.Secondly,the simplified financial system is improved in two aspects.On one side,the number of banks and assets is expanded to make them more in line with the characteristics of the actual financial market.On the other side,the relationship between investment diversification and systemic risk is further studied by distinguishing different topology(such as the random network,the small world network and the scale-free network)and different connectivity of the interbank network.Finally,the relationship between investment diversification and systemic risk is studied in a dynamic evolving financial market.The dynamic evolution mechanism of interbank lending is described through the shortage of cash,and the dynamic investment strategies are determined by the combination of risk appetite and utility function.A relatively complete banking system is constructed in this paper from multiple perspectives to study the relationship between investment diversification and systemic risk.The main conclusions are as follows:(1)The impact of diversification on systemic risk is non-monotonous when interbank loans and fire sales of common assets are considered at the same time.Initially,more investment diversification provides more indirect channels for contagion risk.However,the systemic risk is eliminated after a certain value of investment diversification.Therefore,there is an uncertain relationship between investment diversification and systemic risk.The non-monotonous tendency is more obvious when risks come from small shocks.However,in the case of systemic shocks or endogenous risks caused by the shortage of cash,contagion risks are mainly dispersed with increasing investment diversification.(2)Different topologies of interbank network have different impacts on systemic risk.Among the common interbank networks in real financial market,scale-free networks are the most beneficial to the stability of the banking system,followed by random networks,and small-world networks are most vulnerable.The further research results show that within the reasonable range of the interbank counterparties,the increase of interbank connectivity is not conducive to the stability of the banking system and this feature is particularly evident in scale-free networks and random networks,however,it is weakened by the vulnerability of small-world networks.(3)The results show that fire sale of assets is the main cause of systemic risk.Moreover,risk appetites,heterogeneity,sensitivity of prices and structure of balance sheets can also affect systemic risk.Specifically,controlling the maximum level of risk tolerable can reduce the systemic risk.Heterogeneous banks can improve shortage of cash,while it is also prone to cause more serious systemic risk.In addition,measures such as reducing the interbank lending ratio,increasing the deposit reserve ratio,deleveraging the banking system properly and limiting the decline of asset prices can also increase the stability of the banking system.In particular,the impact of leverage has a certain threshold on systemic risk.Overall,the internal relationship between systemic risks and various factors is revealed in this paper,such as investment diversification,fire sales of assets and interbank loans.The impacts of different measures on systemic risk are also analyzed,which has a reference for the financial regulatory authorities to formulate corresponding policies to control the occurrence of systemic risks.