Interdependence, Vulnerability and Contagion in Financial and Economic Networks

Abstract

Financial and economic networks are neither static nor independent of one another, but are rather quite interconnected with a high level of dependence and mutual influence. In light of global economic convergence, countries depend on one another through trade relations, foreign direct investments, flow of funds in international capital markets, bank borrowing and lending operations, or foreign exchange trading. As economic entities and financial markets become increasingly intertwined, a shock in a financial network can provoke significant cascading failures throughout the global economic system. Here we attempt to understand potential sources of future shocks and whether bubbles and systemic risk build-up in financial networks can be anticipated. We review approaches to study global financial markets and bank networks to uncover system characteristics and relationships that might increase the vulnerability of economic networks. The efficiency of regulatory responses motivated by crisis and the proper level of regulation are extremely important for a sound global economic system.