OnsdagsseminarNorges BankOslo, 10 October 2012Mapping FinancialLandscapes                        Kimmo Soramäki           ...
―When the crisis came, the serious limitations of existingeconomic and financial models immediately became apparent.[...]A...
We did not have maps …                         3
Eratosthenes map of the known world4c. 194 BC
… but what are maps―A set of points, lines, and areas all defined both by position withreference to a coordinate system an...
I. Mapping        II. MappingSystemic Risk   Financial Markets                                    6
I. Mapping Systemic Risk                           7
Systemic risk ≠ systematic risk                                   News articles mentioning ―systemic risk‖, Source: trends...
First Maps                                    Fedwire Interbank Payment                                              Netwo...
This is still shocking …―In 2006, the Federal Reserve invited a group of researchers tostudy the connections between banks...
More Maps                               Bech, M.L. and Atalay, E. (2008), “The Topology of                               t...
Network Theory can be to Financial Mapswhat Cartography is to Geographic MapsMain premise of network theory:Structure of l...
Centrality Measures forFinancial Systems• Existing   – Degree, Closeness, Betweenness     centrality, PageRank, etc.• Debt...
Where are we today?Regulatory response to recent financial crisis was to strengthen macro-prudential supervision with mand...
Norges Bank - Oversight Monitor• Implementing …                                  15(above network is fictional)
II. Mapping Financial Markets                                16
AgendaPurpose of the maps   – Identify price driving themes and     market dynamics   – Reduce complexity   – Spot anomali...
The CaseLehman was the fourth largest investment bank in the US (behindGoldman Sachs, Morgan Stanley, and Merrill Lynch) w...
The Data           Pairwise correlations of           return on 141 global           assets in 5 asset classes           9...
i) Heat Maps                 2004-2007CorporateBondsCDS onGovernmentDebt, 5 yearsFX RatesGovernmentBond Yields            ...
Collapse of Lehman, t=month2004-2007           t-2                   t-1   t+1             t+2                    t+3
ii) Asset TreesOriginally proposed by Rosario Mantegna in 1999Used currently by some major financial institutionsfor marke...
Correlation filtering                             PMFGBalance between too much and too littleinformationOne of many method...
Demo(see http://www.fna.fi/demos/files/assetmonitor.html)   24
iii) Sammon‘s ProjectionProposed by John W. Sammon in IEEE Transactions on Computers 18: 401–409(1969)A nonlinear projecti...
Demo(see http://www.fna.fi/demos/files/lehmansammon.html )   26
Intelligence Amplification•   Intelligence Amplification vs Artificial    Intelligence    William Ross Ashby (1956) in ‗In...
―In the absence of clear guidance from existing analyticalframeworks, policy-makers had to place particular reliance onour...
Blog, Library and Demos at www.fna.fiDr. Kimmo Soramäkikimmo@soramaki.netTwitter: soramaki
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Mapping Financial Landscapes @ Norges Bank

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Financial market turmoil has revealed the interconnected nature of modern financial systems. Industry, regulators and academics agree on the need for better analytical tools that can help monitor and safeguard against systemic risks. Kimmo Soramaki reviews new research in financial network analysis, including how network analysis of large-scale financial transaction data can be used to improve our understanding of how the financial system functions. How can visual analytics of time-series networks bring new insights? How can cross-asset networks enable stronger intuition of market dynamics?

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Transcript of "Mapping Financial Landscapes @ Norges Bank"

  1. 1. OnsdagsseminarNorges BankOslo, 10 October 2012Mapping FinancialLandscapes Kimmo Soramäki Founder and CEO FNA, www.fna.fi
  2. 2. ―When the crisis came, the serious limitations of existingeconomic and financial models immediately became apparent.[...]As a policy-maker during the crisis, I found the availablemodels of limited help. In fact, I would go further: in the face ofthe crisis, we felt abandoned by conventional tools.‖ in a Speech by Jean-Claude Trichet, President of the European Central Bank, Frankfurt, 18 November 2010 2
  3. 3. We did not have maps … 3
  4. 4. Eratosthenes map of the known world4c. 194 BC
  5. 5. … but what are maps―A set of points, lines, and areas all defined both by position withreference to a coordinate system and by their non-spatial attributes‖Data is encoded as size, shape, value, texture or pattern, color andorientation of the points, lines and areas – everything has a meaningCartographer selects only the information that is essential to fulfill thepurpose of the mapMaps reduce multidimensional data into a two (or three) dimensionalspace that is better understood by humansMaps are intelligence amplification, they aid in decision making andbuild intuition 5
  6. 6. I. Mapping II. MappingSystemic Risk Financial Markets 6
  7. 7. I. Mapping Systemic Risk 7
  8. 8. Systemic risk ≠ systematic risk News articles mentioning ―systemic risk‖, Source: trends.google.comThe risk that a system composed of many interactingparts fails (due to a shock to some of its parts).In Finance, the risk that a disturbance in the financialsystem propagates and makes the system unable toperform its function – i.e. allocate capital efficiently. Not:Domino effects, cascading failures, financialinterlinkages, … -> i.e. a process in the financialnetwork 8
  9. 9. First Maps Fedwire Interbank Payment Network, Fall 2001 Around 8000 banks, 66 banks comprise 75% of value,25 banks completely connected Similar to other socio- technological networks Soramäki, Bech, Beyeler, Glass and Arnold M. Boss, H. Elsinger, M. Summer, S. Thurner, The (2007), Physica A, Vol. 379, pp 317-333. network topology of the interbank market, Santa See: www.fna.fi/papers/physa2007sbagb.pdf Fe Institute Working Paper 03- 9 10-054, 2003.
  10. 10. This is still shocking …―In 2006, the Federal Reserve invited a group of researchers tostudy the connections between banks by analyzing data from theFedwire system, which the banks use to back one another up.What they discovered was shocking: Just sixty-six banks — out ofthousands — accounted for 75 percent of all the transfers. Andtwenty five of these were completely interconnected to oneanother, including a firm you may have heard of called LehmanBrothers.‖ Want to Build Resilience? Kill the Complexity Harvard Business Review Blogs, 9/2012 10
  11. 11. More Maps Bech, M.L. and Atalay, E. (2008), “The Topology of the Federal Funds Market”. ECB Working Paper No. 986. Italian money market Iori G, G de Masi, O Precup, G Gabbi and G Caldarelli (2008): “A network analysis of the Italian overnight money market”, Journal of Economic Dynamics and Control, vol. 32(1), pages 259-278Federal funds Unsecured Sterling money market Wetherilt, A. P. Zimmerman, and K. Soramäki (2008), “The sterling unsecured loan market during 2006–2008: insights from network topology“, in Leinonen (ed), BoF Scientific monographs, E 42 Cross-border bank lending Minoiu, Camelia and Reyes, Javier A. (2010). A network analysis of global 11 banking:1978-2009. IMF Working Paper WP/11/74.
  12. 12. Network Theory can be to Financial Mapswhat Cartography is to Geographic MapsMain premise of network theory:Structure of links between nodesmattersTo understand the behavior of onenode, one must analyze thebehavior of nodes that may beseveral links apart in the networkTopics:Centrality, Communities, Layouts,Spreading and generationprocesses, Path finding, etc. 12
  13. 13. Centrality Measures forFinancial Systems• Existing – Degree, Closeness, Betweenness centrality, PageRank, etc.• DebtRank – Battiston et al, Science Reports, 2012 – Feedback-centrality – Solvency cascade• SinkRank – Soramäki and Cook, Kiel Economics DP, 2012 – Transfer along walks – Liquidity absorption 13
  14. 14. Where are we today?Regulatory response to recent financial crisis was to strengthen macro-prudential supervision with mandates for more regulatory data―Big data‖ and ―Complex Data‖-> Challenge to understand, utilize andoperationalize the dataGrowing body of empirical research, see www.fna.fi/libraryPromise of ―Analytics based policy and regulation‖, i.e. the applicationof computer technology, operations research, and statistics to supporthuman decision making 14
  15. 15. Norges Bank - Oversight Monitor• Implementing … 15(above network is fictional)
  16. 16. II. Mapping Financial Markets 16
  17. 17. AgendaPurpose of the maps – Identify price driving themes and market dynamics – Reduce complexity – Spot anomalies – Build intuitionThe maps: Heat Maps, Asset Trees andSammon‘s ProjectionsThese methods are showcased forvisualizing markets around thecollapse of Lehman brothers 17
  18. 18. The CaseLehman was the fourth largest investment bank in the US (behindGoldman Sachs, Morgan Stanley, and Merrill Lynch) with 26.000employeesAt bankruptcy Lehman had $750 billion debt and $639 billion assetsCollapse was due to losses in subprime holdings and inability to findfunding due to extreme market conditionsIs seen as a divisive point in the 2007-2009 financial crisisWe create 3 visualization of a 5 month period around the failure (15September 2008) from asset price data 18
  19. 19. The Data Pairwise correlations of return on 141 global assets in 5 asset classes 9870 data points per time interval 5 intervals, 2 months before and 3 months after Lehman collapse 19
  20. 20. i) Heat Maps 2004-2007CorporateBondsCDS onGovernmentDebt, 5 yearsFX RatesGovernmentBond Yields Correlation -1StockExchange 0Indices +1 20
  21. 21. Collapse of Lehman, t=month2004-2007 t-2 t-1 t+1 t+2 t+3
  22. 22. ii) Asset TreesOriginally proposed by Rosario Mantegna in 1999Used currently by some major financial institutionsfor market analysis and portfolio optimization andvisualizationMethodology in a nutshell MST 1. Calculate (daily) asset returns 2. Calculate pairwise Pearson correlations of returns 3. Convert correlations to distances 4. Extract Minimum Spanning Tree (MST) 5. Visualize (as phylogenetic trees) 22
  23. 23. Correlation filtering PMFGBalance between too much and too littleinformationOne of many methods to create networksfrom correlation/distance matrices – PMFGs, Partial Correlation Networks, Influence Networks, Granger Causality, Influence Network Long Range Covariance, etc.New graph, information-theory, economics& statistics -based models are beingactively developed 23
  24. 24. Demo(see http://www.fna.fi/demos/files/assetmonitor.html) 24
  25. 25. iii) Sammon‘s ProjectionProposed by John W. Sammon in IEEE Transactions on Computers 18: 401–409(1969)A nonlinear projection method to map ahigh dimensional space onto a space oflower dimensionality. Example: Iris Setosa Iris Versicolor Iris Virginica 25
  26. 26. Demo(see http://www.fna.fi/demos/files/lehmansammon.html ) 26
  27. 27. Intelligence Amplification• Intelligence Amplification vs Artificial Intelligence William Ross Ashby (1956) in ‗Introduction to Cybernetics‘• Technology, products and practices change constantly, market knowledge is essential Game of Go (from China).• Algorithms don‘t fare well in periods of Computer programs only get to abrupt change, algorithms do not think human amateur level due to good outside the box pattern recognition capabilities needed in the game.• Build intuition and mental maps 27
  28. 28. ―In the absence of clear guidance from existing analyticalframeworks, policy-makers had to place particular reliance onour experience. Judgment and experience inevitably played akey role.‖ in a Speech by Jean-Claude Trichet, President of the European Central Bank, Frankfurt, 18 November 2010 28
  29. 29. Blog, Library and Demos at www.fna.fiDr. Kimmo Soramäkikimmo@soramaki.netTwitter: soramaki
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