Optimal Network Compression
This addresses network stability and risk management for financial regulators and institutions, but it is incremental as it builds on existing formulations and results.
The paper tackles the optimal network compression problem in financial systems, proving it is NP-hard and analyzing the suboptimality of maximally compressed networks under systemic risk measures, finding that robust fragility results from prior work do not hold under systematic shocks and heterogeneous networks.
This paper introduces a formulation of the optimal network compression problem for financial systems. This general formulation is presented for different levels of network compression or rerouting allowed from the initial interbank network. We prove that this problem is, generically, NP-hard. We focus on objective functions generated by systemic risk measures under shocks to the financial network. We use this framework to study the (sub)optimality of the maximally compressed network. We conclude by studying the optimal compression problem for specific networks; this permits us to study, e.g., the so-called robust fragility of certain network topologies more generally as well as the potential benefits and costs of network compression. In particular, under systematic shocks and heterogeneous financial networks the robust fragility results of Acemoglu et al. (2015) no longer hold generally.