Abstract
Purpose: This paper empirically investigates the structural evolution of global financial systems from the system of systems (SoS) view for eleven countries. The financial SoS consists of eleven countries each of which has its own financial system with relative autonomy. The paper aims to provide a prototype of the structural dynamics of the global financial SoS for the eleven financial entities during different phases of the financial markets. Methodology/Approach: The graph-theoretic approach of minimum spanning trees (MST) is applied on two levels to construct the component level of a subsystem within each country and the systemic level of global financial SoS. An SoS can be viewed as a network of networks (NoN) of financial transactions. The statistical approach of principal components analysis (PCA) is also applied to the systemic level of financial SoS among geographic countries to find the driving factor of variance. Originality/Value: This study provides an empirical quantitative measure of systemic risk and applies it to the global SoS to describe the interconnections and linkages. This paper examines the transmission of risks among the components. The structural dynamics of the SoS is expected to be a function of economic cycles including episodes of economic expansion and contraction. Findings: The average distance of component level MST is found to be lower during an economic contraction and higher during an economic expansion. The systemic level MST of global SoS can successfully reflect the geographic as well as the economic relationship between countries. The model verifies the intuition on natural clusters of Germany-France-Italy and the USA-Canada-UK as implied by the tight economic interconnections in each cluster. The result from PCA shows the USA, UK, and Australia experienced a counter movement compared to other European countries during the Euro debt crisis. The Japan financial system contraction and expansion can be explained by other countries indicating that it does not appear to be the driving factor of global SoS over the period of the data sample.
Highlights
The recent subprime mortgage crisis in 2008 exposed the weaknesses of the financial system both in the U.S and globally
We describe the dynamics of the average distance of minimum spanning trees (MST) as a systemic risk indicator in the U.S market through the entire business cycles and provide the conclusion of how a component expands and contracts from prosperity to turmoil
Our systemic risk coupling indicator postulated that systemic risk is inversely proportionate to the average MST distance
Summary
The recent subprime mortgage crisis in 2008 exposed the weaknesses of the financial system both in the U.S and globally. Evans and Hnatkovska [2] investigated how international financial integration affects the behavior of international capital flows and asset prices. They declared that international financial integration capital flows are large and volatile at the beginning stage. They demonstrated that global risk factors have become more important in determining excess equity returns. The banking system, albeit most important in a financial system, is only one component in the SoS configuration. It is important to explore the financial systems from the perspective of SoS and examine, as a whole, the relative movements of the components
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