Matrix Metrics: Network-Based Systemic Risk Scoring

Abstract

I propose a novel framework for network-based systemic risk measurement and management. A new systemic risk score is defined that depends on the level of individual risk at each financial institution and the interconnectedness across institutions, and is generally applicable irrespective of how interconnectedness is defined. This risk metric is decomposable into risk contributions from each entity, forming a basis for taxing each entity appropriately. We may calculate risk increments to assess potential risk of each entity on the overall financial system. The paper develops other risk measures such as system fragility and entity criticality. An assessment using a measure of spillover risk is obtained to determine the scale of externalities that one bank might impose on the system; the metric is robust to this cross risk, and does not induce predatory spillovers. The analysis shows that splitting up too-big-to-fail banks from the system does not lower systemic risk.