How does the supervision stringency affect systemic risk based on the differential dynamic model?

• Main Authors: Bian Chenyu, Yang Haomiao, Zhang Ning
• Format: Article
• Language: English
• Published: Taylor & Francis Group 2019-01-01
• Series: Systems Science & Control Engineering
• Subjects: Systematic risk; supervision stringency; differential dynamic equilibrium
• Online Access: http://dx.doi.org/10.1080/21642583.2019.1681031

This paper focused on the supervision stringency and studied its impact on the financial system risk contagion mechanism. This paper adopts Susceptible-Exposed-Infected-Recovered epidemical model and sets supervision stringency as the principal parameter. The model was formed by a differential equation set and financial system are set with Susceptible group, Exposed group, Infectious A, Infectious B, and Removed group. Based on the theoretical research, this paper gave the steady-state solution and the robust conditions for equilibrium. The conclusion is that in a short time, a small portion of Susceptible group and Exposed group will become Removed group, while a big portion rapidly becomes Infectious A, B. The rate and quantity of other institutions infected is much higher than systematically important financial institutions. Meanwhile, it is known that enhancing supervision stringency is instrumental in alleviating risk spill-over effect of other institutions and risk contagion among institutions. Under system equilibrium, the number of infectious institutions gradually decreases with supervision stringency increasing. Furthermore, the appropriate enhancement of supervision stringency can avoid risk eruption, whereas risk contagion could outbreak if supervision was overstringent.