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Ever since the devastating financial crisis of 2008, researchers have been probing the financial markets to understand what went wrong and how to prevent another crippling recession.
A Cornell University statistician and his colleagues have found some answers to those questions through analyzing the crisis by mapping out whether and how two specific networks interacted as the crisis evolved, rather than looking at the financial markets' networks one at a time.
Crisis - Banks - Stock - Prices - Deviation
During the crisis, European banks stopped lending to each other, while their stock prices became highly correlated—a significant deviation from the two networks' normal interaction, according to the study. The finding offers insights into how to tell if another financial crisis is starting to brew in the future. The research, "Interconnectedness in the Interbank Market," will appear in a future issue of the Journal of Financial Economics.
"The interbank market provides information on financial markets and the real economy that compliments the information derived from public stock returns," said co-author Shawn Mankad, assistant professor of operations, technology and information management at the Samuel Curtis Johnson Graduate School of Management. "The work suggests both of these data sources should be utilized in early warning systems or any type of prediction model."
Advances - Network - Analysis - Mankad - Behavior
Leveraging recent advances in network analysis, Mankad studied the behavior of the European interbank market, in which banks lend and borrow from each other, before, during and after the 2008 financial crisis. To define the market more clearly, he created two new terms to describe two networks: the correlation network of banks' stock returns, and the physical network of interbank trading.
Describing the correlation network, Mankad said: "If the stock prices of, say, Bank of America and JPMorgan Chase are moving together sufficiently on a graph, then we say they're highly correlated."
Network - Interbank - Trading - Transactions - Banks
And the physical network of interbank trading is comprised of transactions between banks...
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