Concurrent Session 1B:Mapping Financial Landscapes

Kimmo SoramäkiSpeaker

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“When the crisis came, the serious limitations of existing economic and financial models immediately became apparent. [...] As a policy-maker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.”

in a Speech by Jean-Claude Trichet, President of the European Central Bank, Frankfurt, 18 November 2010

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We did not have maps …

4Eratosthenes' map of the known world c. 194 BC

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Fedwire payment network• Total of ~8000 banks

• 66 banks comprise 75% of value

• 25 banks completely connected

• Scale-free degree distribution

• Similar to other socio-technological networks

Soramäki, Bech, Beyeler, Glass and Arnold (2007), Physica A, Vol. 379, pp 317-333.

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Financial and geographic maps

Similarities • Are visualizations of multivariate data• Have global and local views• Alter and aid decision making

Differences - Financial Maps:• Relationships are not spatial• Change faster than tectonic plates

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Agenda

Mapping Systemic RiskMapping Market DataNetwork Theory

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Mapping systemic risk

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Systemic risk ≠ systematic risk

• The risk of disruption to a financial entity with spillovers to the real economy

• Risk of a crisis that stresses key intermediation markets and leads to their breakdown, which impacts the broader economy and requires government intervention

• Risk that critical nodes of a financial network cease to function as designed, disrupting linkages

-> some chain of events that starts or gets magnified in the finance sector and makes us all worse off

News articles mentioning “systemic risk”, Source: trends.google.com

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Background

• Regulatory response to recent financial crisis was to strengthen macro-prudential supervision with mandates for more regulatory data.

• The challenge now is to understand and utilize the data

• Analytics based policy and regulation, i.e. the application of computer technology, operations research,and statistics to support decision making

Katsushika Hokusai. The great wave off Kanagawa ~1830

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Research

• A growing body of empirical research on financial networks from a systemic risk perspective

• Interbank payment flows– Soramäki et al (2006), Becher et al. (2008), Boss et al. (2008), Pröpper et al.

(2009), Embree and Roberts (2009), Akram and Christophersen (2010) …

• Overnight loans networks– Atalay and Bech (2008), Bech and Bonde (2009), Wetherilt et al. (2009), Iori et

al. (2008) and Heijmans et al. (2010), Craig & von Peter (2010) …

• Flow of funds, Credit registry, Stock trading… – Castren and Kavonius (2009), Bastos e Santos and Cont (2010), Garrett et al.

2011, Minoiu and Reyes (2011), Adamic et al. (2009), Jiang and Zhou (2011) …

• More at www.fna.fi/library

12Minoiu, Camelia and Reyes, Javier A. (2010). A network analysis of global banking:1978-2009. IMF Working Paper WP/11/74.

Federal funds

Bech, M.L. and Atalay, E. (2008), “The Topology of the Federal Funds Market”. ECB Working Paper No. 986.

Iori G, G de Masi, O Precup, G Gabbi and G Caldarelli (2008): “A network analysis of the Italian overnight money market”, Journal of Economic Dynamics and Control, vol. 32(1), pages 259-278

Italian money market

Wetherilt, A. P. Zimmerman, and K. Soramäki (2008), “The sterling unsecured loan market during 2006–2008: insights from network topology“, in Leinonen (ed), BoF Scientific monographs, E 42

Unsecured Sterling money market

Visualizing Financial Networks

Cross-border bank lending

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The New York Times, 1 May 2010Europe's Web of Debt

14http://www.bbc.co.uk/news/business-15748696

BBC, 18 November 2011Eurozone debt web: Who owes what to whom?

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net_id from_id to_id value2005-1Q Australia Austria 4992005-1Q Australia Belgium 11352005-1Q Australia Canada 18842005-1Q Australia Finland 5532005-1Q Australia France 5028…

Example 1: BIS consolidated banking statistics

• The Bank for International Settlements (BIS) consolidated banking sector statistics (item 9D), http://www.bis.org/statistics/consstats.htm

• Data on banks' on-balance sheet financial claims by country • Provide a measure of the risk exposures of lenders' national

banking systems.• Only countries reporting both exposures from and to are

included

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• ‘Chord diagram’

• Using D3 library based on work on Circos

• Implemented in FNA

• Link to interactive version

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Centrality

• Degree: number of links

• Closeness: distance to other nodes via shortest paths

• Betweenness: number of shortest paths going through the node

• Eigenvector: nodes that are linked by/toother important nodes are more central

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• Network layout

• Node size scales with PageRank

• Link width scales with value of exposure

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Mapping financial markets

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Correlation matrix

• Pairwise correlations of 141 assets, 9927 data points

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• Heatmap

• Deep blue ->strong negativecorrelation

• Deep red ->strong positivecorrelation

• Link to interactive version

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• We consider only the Maximum Spanning Tree of absolute correlations

• 140 unique data points-> links

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• Network visualization of correlation tree

• Clear clustering of asset classes

• Size of nodes scales with their degree centrality

• Joint work with Jochen Papenbrock, Firamis UG (Germany)

• Link to interactive version

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• Link lengths scale with correlation

• Mapping change and time-series

• Link to interactive version

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Intelligence Amplification• A solution is to augment human

intelligence • Intelligence Amplification vs

Artificial Intelligence

William Ross Ashby (1956) in ‘Introduction to Cybernetics’

• Technology, products and practices change constantly, market knowledge is essential

• Algorithms don’t fare well in periods of abrupt change, algorithms do not think outside the box

• Data reduction

Game of Go (from China).

Computer programs only get to human amateur level due to good pattern recognition capabilities needed in the game.

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Network Theory is to Financial Maps what Cartography is to Geographic Maps

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NETWORK THEORY

Financial Network Analysis

Biological Network Analysis

Graph & Matrix Theory

Social Network Analysis

Network Science

Computer Science

Network theory and related fields

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Main premise of network theory: Structure of links between nodes matters

• The properties and behavior of a node cannot be analyzed on the basis its own properties and behavior alone.

• To understand the behavior of one node, one must analyze the behavior of nodes that may be several links apart in the network.

• Financial contexts– Trading networks, payment networks, exposure networks– Networks of interconnected balance sheets– Networks of asset dependencies

• Topics: Centrality, Communities, Layouts, Spreading and generation processes, Path finding, etc.

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FNA.fi - Open platform for Financial Network Analysis

www.fna.fi – Open platform for Financial Network Analysis

Contact: kimmo@soramaki.net

Twitter: soramaki

Thank you!