Presentation at Forecasting financial crisis topical sesson at ETH Workshop on Coping with Crisis in Complex Socio-Economic Systems 23 June

2011

Tools for forecasting financial crisis

Kimmo Soramki Soramaki Networks Oy

kimmo@soramaki.net

Are we forecasting:
Timing, Process , or Outcome?

Micro or Macro events?

Outline
Three components of models
Topology of interactions System dynamics Economic behavior

How to bring research to policy? Financial Network Analytics -software

Payment systems
2.50E+15

~1939 tr
2.00E+15

1.50E+15

1.00E+15

5.00E+14

~194 tr
0.00E+00 Annual value (euros) Liquidity need

~120 tr ~5 tr
Age Age of of the the universe universe (hours) (days)

Bech, Preisig and Soramki (2008), FRBNY Economic Review, Vol. 14, No. 2.

Topology of interactions
Degree distribution

Total of ~8000 banks 66 banks comprise 75% of value 25 banks completely connected

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

Complex dynamics
Central bank 4 Payment account
is debited

Payment system
Bi Bj

5 Payment account
is credited

6 Depositor account 3 Payment is settled

or queued is credited

Qi

Bi > 0

Di

2 Depositor account
is debited

Bank i

Liquidity Market

Dj

Qj > 0

Qj

Bank j

7 Queued payment,
if any, is released

Agent instructs bank to send a payment

Productive Agent

Productive Agent
Beyeler, Glass, Bech and Soramki (2007), Physica A, 384-2, pp 693-718.

Payment System Instructions

Time

Payments

Liquidity
When liquidity is high payments are submitted promptly and banks process payments independently of each other

Time

Payments

Summed over the network, instructions arrive at a steady rate

Instructions

Payment System Instructions

Time

Payments

Liquidity

Time

Reducing liquidity leads to episodes of congestion when queues build, and cascades of settlement activity when incoming payments allow banks to work off queues. Payment processing becomes coupled across the network

Frequency

Cascade Length

Payments

Instructions

Complex dynamics
Central bank 4 Payment account
is debited

Payment system
Bi Bj

5 Payment account
is credited

6 Depositor account 3 Payment is settled

or queued is credited

Qi

Bi > 0

Di

2 Depositor account
is debited

Bank i

Liquidity Market

Dj

Qj > 0

Qj

Bank j

7 Queued payment,
if any, is released

Agent instructs bank to send a payment

Productive Agent

Productive Agent
Beyeler, Glass, Bech and Soramki (2007), Physica A, 384-2, pp 693-718.

Economic behavior
Example: How much liquidity to post? Cost for a bank in a payment system depends on
Choice of liquidity and Delays of settlement

Banks liquidity choice depends on other banks liquidity choice We develop ABM
payoffs determined by a realistic settlement process reinforcement learning look at equilibrium

Galbiati and Soramki (2011), JEDC, Vol. 35, Iss. 6, pp 859-875

Liquidity demand curve

How to operationalize all this?

Data tsunami
Digital information is doubling every 1.2 years. Open data, data science, 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 policy, i.e. the application of computer technology, operational research, and statistics to solve regulatory problems

Katsushika Hokusai. The great wave off Kanagawa ~1830

Network maps
Recent financial crisis brought to light the need to look at links between financial institutions Natural way to visualize the financial system Network thinking widespread by regulators Mapping of the financial system has only begun

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

Intelligence
Financial crisis are different and rare Technology, products and practices change Data is not clean, actions are not rational Hard to develop algorithms

A solution is to augment human intelligence (in contrast to AI and algorithms)

Objectives
Provide a tool for exploration, analysis and visualization of regulatory financial data
Provide a extendible platform for custom functionality, and agent based and simulation models

Make advances in research available to policy

Roots of the work

Bof-PSS2
Bank of Finland, 1997 Payment system simulator used in ~60 central banks

Loki
NISAC at Sandia National Laboratories, 2004 Toolkit for network analysis and ABM

Sponsored by Norges Bank, collaborative efforts with other central banks

Scope

Research

Policy

Operations

Paradigm

Data validation

Analysis and modeling

Visualization

demo

www.fna.fi

Thank you

Contact us kimmo.soramaki@fna.fi