Network Connectivity, Systemic and Systematic Risk

The project aims to shed light on understanding the propagation mechanisms behind the recent financial crisis. Part of the literature postulates that systemic risk is strictly related (if not equal to) systematic risk. In this extension, we will elaborate on this hypothesis and introduce a modeling framework where systemic and systematic risks co-exist. The model is a simplification of the Branger et al. (2014) model and a variation of the traditional Capital Asset Pricing Model (CAPM) where networks are used to infer the exogenous/lagged and contemporaneous links across assets. The econometric approach used to estimate the model refers to the spatial econometric framework, namely the use of concentrated likelihoods. In our framework network, connections are exogenously provided by direct exposures and indirect exposures.

The project has allowed extending the classic factor-based asset pricing model by including network linkages in linear factor models. We assume that the network linkages are exogenously provided. This extension of the model allows a better understanding of the causes of systematic risk.