Financial Network Analytics

Kimmo Soramäki | www.fna.fikimmo@soramaki.net

Liverpool UniversityResearch Cluster “Probability Theory, Financial and Actuarial Mathematics8 February 2012

“When the crisis came, the serious limitations of existing economic and financial models immediately became apparent. [...] As a policy-maker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.”

in a Speech by Jean-Claude Trichet, President of the European Central Bank, Frankfurt, 18 November 2010

NETWORK THEORY

Financial Network Analysis

Biological Network Analysis

Graph & Matrix Theory

Social Network Analysis

Network Science

Computer Science

Network theory and related fields

www.fna.fi/library

Why networks?

Katsushika Hokusai. The great wave off Kanagawa ~1830

Data tsunami

• Digital information is doubling every 1.2 years -> Big Data, Open Data, Data Science, ‘Chief Algorithms Officers’…

• Regulatory response to recent financial crisis was to strengthen macro-prudential supervision with mandates for more regulatory data

• The challenge will be to understand and analyze the data

• Analytics based decision-making, i.e. the application of computer technology, operational research,and statistics to support decision making

Katsushika Hokusai. The great wave off Kanagawa ~1830

Eratosthenes' map of the known world c. 194 BC

Network maps

• Natural way to visualize the financial system• Network visualizations are intuitive• Maps aid decision making• Mapping of the financial system

has only begun

Eratosthenes' map of the known world, c. 194 BC.

Go is a board game that originated in China more than 2,000 years ago.

Intelligence Amplification

• Technology, products and practices change constantly

• Data is not clean, actions are not ‘rational’

• Algorithms don’t fare well in periods of abrupt change

• Algorithms do not think outside the box

• A solution is to augment human intelligence

• Intelligence Amplification vs Artificial Intelligence

What is a/the financial network?

Main premise of network analysis: Structure of links between nodes matters

• The properties and behavior of a node cannot be analyzed on the basis its own properties and behavior alone.

• To understand the behavior of one node, one must analyze the behavior of nodes that may be several links apart in the network.

• Bottom up approach. Generalize and describe.

• Financial contexts– Trading networks, payment networks– Networks of interconnected balance sheets– Networks of asset dependencies

Central theme: Centrality

• Degree: number of links

• Closeness: distance to other nodes via shortest paths

• Betweenness: number of shortest paths going through the node

• Eigenvector: nodes that are linked by/toother important nodes are more central

15

Trajectory geodesic paths, paths, trails or walksTransmission parallel/serial duplication or transfer

Source: Borgatti (2004)

Centrality depends on network process

Topology of interactions

Total of ~8000 banks66 banks comprise 75% of value25 banks completely connected

Degree distribution

Soramäki, Bech, Beyeler, Glass and Arnold (2006), Physica A, Vol. 379, pp 317-333.

The New York Times, 1 May 2010Europe's Web of Debt

http://www.bbc.co.uk/news/business-15748696

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BBC, 18 November 2011Eurozone debt web: Who owes what to whom?

• Claims of banking sector by country

Country exposures networks

Stock correlation networks

• Cross-asset correlation tree ofGerman DAX index stocks

• Assets are linked in a backbone correlation network

• Clusters of asset classes clearly visible

• Data reduction method

Cross asset network

Financial Network Analytics

Financial Network Analytics (FNA)

FNA is an analytics platform that helps banks and financial regulators manage and understand financial data with network analysis

• Web Service (www.fna.fi) and Enterprise Software

• Modular design, current modules for:– Financial Stability– Payment System Oversight – Macroprudential Supervision and – Cross Asset Analysis

• Designed for operationalizing latest research

Financial Network Analytics Platform

Develop Monitor

Demos

• Bilateral banking sector exposures by country (2005-2011)– Node = country, Link = banking system exposure – Force-Directed layout of network

• Asset correlation data for DAX stocks (January 2012)– Node = stock, Link = coupling via correlations– Dynamic Force-Directed layout of spanning tree

• Dashboards

26www.fna.fi

for more information