Eliminating Systemic Risk in Financial Markets

Stefan Thurner

Systemic risk in financial markets arises—to an important extent—from the interconnectedness of agents via financial contracts. We show that the systemic risk level of every player in a financial system can be quantified by simple network measures. Using central bank data from Austria and Mexico, we compute the total expected systemic losses of an economy, a number that allows us to estimate the cost of a financial crises. We further show how to compute the systemic risk contribution of every single transaction to the financial system. We propose a simple financial transaction tax that incentivizes players to avoid systemically risky transactions. Avoiding this tax effectively restructures the topology of financial networks so that large-scale contagion events become impossible. We prove the existence of a systemically risk-optimal equilibrium under this tax. We demonstrate that this Systemic Risk Tax practically eliminates the network-component of systemic risk in the system.