Measuring Global Financial Linkages: A Network Entropy Approach

Daeyup Lee,Hail Park

doi:10.3390/su11174691

Abstract

This paper measures the diversity of highly-connected financial networks using network entropy, and policy-related findings emerge from this research. With respect to the time variation of network entropy, international diversification of the global financial network constructed from foreign claims of international banks has decreased since the financial crisis of 2007–2008, while foreign claims among 20 reporting countries have concentrated more on core countries, such as the US and UK, since 2009. This change is more vividly captured by network entropy due to an unprecedented drop in the measurement. The results suggest that network entropy has promising potential in the financial market.

Highlights

The recent financial crises highlight the importance of interconnected global financial markets in the global economy [1]
This paper aims to contribute to understanding the network structure of global financial markets by providing a network entropy measure of network diversity, or international diversification, proposed by [10] and readily applicable to highly connected networks
This paper proposes network entropy as a tool for measuring the diversity of highly connected financial networks

Summary

Introduction

The recent financial crises highlight the importance of interconnected global financial markets in the global economy [1]. With the literature on financial networks growing rapidly, the empirical works can be divided into two strands. One of those strands focuses on data-based investigations of financial networks to identify and understand their features. [2] used the BIS (Bank for International Settlements) consolidated banking sector statistics to investigate cross-border exposure and provided several vulnerability measures. The borrower concentration ratio, which is based on the Herfindahl index, and is similar to entropy in the sense that two measures gauge the extent of the diversification of lending. [4] built a bank-level global financial network and identified a systematic effect of recessions and banking crises on the global banking network. They found that connectivity tends to decline during and after financial crises. [4] built a bank-level global financial network and identified a systematic effect of recessions and banking crises on the global banking network. [5] extended a cross-border network of the banking sectors in the Euro area to include sector networks of each country and highlight the tradeoff between efficiency and stability in financial networks

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Conclusion