Network relationships and network
   models in payment systems

           Kimmo Soramäki (ECB)
   Morten Bech and Jeffrey...
Introduction


  • any network can be modeled as a graph with nodes
    and links between the nodes

  • this presentation...
What can the results be used for?

  • to better understand the topology of liquidity flows in
    payment systems
  • to ...
Some terminology

  • Graphs are made up by nodes                    B
    and links between the nodes
                   ...
Basic network models I: Erdos-Renyi

  • Erdos-Renyi model (50’s)
  • classical random network
  • start with N nodes, and...
Basic network models II: Barabasi-Albert

  • start with a small number of nodes
  • growth: at each step add a node and l...
Interbank payment networks
  •   how to define the network depends on the question one wishes to
      study

  Options:

...
Network fundamentals used

  • we use payment data from Fedwire to illustrate liquidity
    flows among banks in a payment...
Basic statistics
  averages for 62 daily networks:

  • banks (n)                       5,086
  • links (l)               ...
Visualising the network
                                      •   example random
                                         ...
Components of the created network
                                                GSCC: Giant strongly
                   ...
Degree Distribution                                                       what kind of hierarchy
                         ...
The power law distribution
  • the slope of the distribution is defined by the co-efficient
    γ, P(k)~k-γ
     – for our...
Number of payments on a link
probability of 1
   payment                                   Distribution of Link Weights (N...
Value of payments on a link

                                         Distribution of Edge Weights (Value)
               ...
Average Path Length                                                                                how dense is the networ...
Clustering                                                                how are banks connected locally?


             ...
Relevance of the numbers?
 • We don’t know yet. Some hypotheses:

 • Degree distribution and link weights (power law)
    ...
Summary

 • payment systems are just one of many similar networks

 • the statistics presented here are just scratch the s...
auxiliary slides




                   19
Other scale-free networks ...
 A                                                         B




                        Sou...
Average nearest neighbour degree

average
                                           Average Nearest Neighbor Out Degree
d...
Link weights and degree
                     Average Edge Weights (Number) by Out-Degree
           20



           15
  ...
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Network relationships and network models in payment systems

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This presentation introduces concepts from graph theory and network science and applies them to describe liquidity flows in payment systems. It is one of three components in our approach for modelling payment systems: Complex network, Complex behavior, and Adaptation.

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Network relationships and network models in payment systems

  1. 1. Network relationships and network models in payment systems Kimmo Soramäki (ECB) Morten Bech and Jeffrey Arnold (FRBNY) Walter Beyeler and Robert J. Glass (Sandia National Laboratories) Bank of Finland, Helsinki, 24 August 2005 0
  2. 2. Introduction • any network can be modeled as a graph with nodes and links between the nodes • this presentation introduces concepts from graph theory and network science and applies them to describe liquidity flows in payment systems • it is one of three components in our approach for modelling payment systems: Complex network, Complex behavior, and Adaptation 1
  3. 3. What can the results be used for? • to better understand the topology of liquidity flows in payment systems • to better understand the spill-over effects of liquidity disturbances • for identifying important banks • to possibly devise financial fragility indicators on the basis of the topology • to analyze long-term structural changes and spot the impact of abnormal events • to generate artificial data – we can compare the model’s statistical properties with the one of the actual system 2
  4. 4. Some terminology • Graphs are made up by nodes B and links between the nodes A C • Links can be either directed, or undirected D E • Links can have weights • A path is a sequence of nodes in which each node is linked to the next one (e.g. EDCA is a path of length 3) • The degree of a node is the number of links from (out- degree) or to it (in-degree) from other nodes • A cluster is a set of nodes that all have links with each other (e.g. ABC) 3
  5. 5. Basic network models I: Erdos-Renyi • Erdos-Renyi model (50’s) • classical random network • start with N nodes, and connect pairs at random until desired connectivity is reached The ER model degree distribution follows the Poisson distribution 4
  6. 6. Basic network models II: Barabasi-Albert • start with a small number of nodes • growth: at each step add a node and link it to one existing node • preferential attachment: nodes with a higher number of incoming links have a higher likelihood of being selected • continue until desired number of nodes have been created The BA model degree distribution follows the power law 5
  7. 7. Interbank payment networks • how to define the network depends on the question one wishes to study Options: • which payment system participants to include? – all, commercial banks, settlement institutions, ... • what kind of interaction? – a payment, exchange of payments, a debt relationship, ... • how long do we observe the formation of the network? – an hour, a day, a week, ... • how intense should the interaction be – certain number, certain value of payments, ... 6
  8. 8. Network fundamentals used • we use payment data from Fedwire to illustrate liquidity flows among banks in a payment system • other large-scale payment systems are likely to exhibit the same properties • in particular, we build – daily networks. If one ore more payments are transacted from a bank to another, we establish a directed link from the bank to the other • we consider only – payments between commercial banks, – that are not related to overnight funding 7
  9. 9. Basic statistics averages for 62 daily networks: • banks (n) 5,086 • links (l) 85,585 – possible links, n*(n-1) 25,862,310 – connectivity, l / n*(n-1) 0.3% – reciprocity 21.5% (share of two-way links) • value 1,302 billion • number 435,533 – average payment size 3.0 million 8
  10. 10. Visualising the network • example random scale-free network of 100 nodes and 680 links • similar topology as in the liquidity flows • small core with high flows (red lines) • large periphery with low flows (black lines) • visualising larger Pajek.exe networks difficult 9
  11. 11. Components of the created network GSCC: Giant strongly connected component. The core of the network. Tendrils All banks reachable from any other bank. Disconnected components Giant Giant GIN: All banks that can in- out- component reach the GSCC GSCC component (GIN) (GOUT) GOUT: All banks reachable from GSCC Tendrils GWCC Tendrils: Banks that are not reachable nor reach the GSCC GWCC: Giant weakly connected component. All banks in this component can be reached via undirected links from each other 10
  12. 12. Degree Distribution what kind of hierarchy does the network have? probability of Out Degree Distribution degree 1 ~ 13% Fedwire Banks: Directed-Strong Gross Largest Component 1st Quarter 2004 0 -1 probability of degree 100 ~ Log10 of P(k) -2 0.02% -3 -4 probability of -5 degree 10 ~ 2% -6 0 1 2 3 4 Log10 of Degree(k) Empirical ER model (p=0.0015) BA model (m=15) average degree = 15 11
  13. 13. The power law distribution • the slope of the distribution is defined by the co-efficient γ, P(k)~k-γ – for our network γ = 2.1 • examples of other networks – internet, router level γ = 2.4 – movie actor collaboration network γ = 2.3 – co-authorship network of physicists γ = 2.5 – co-authorship network of neuroscientist γ = 2.1 • networks with a power law degree distribution are called scale-free • sometimes said to be the new ”normal distribution” as the distribution of many man-made and natural events have this distribution – the size of earthquakes, stock market movements, ... 12
  14. 14. Number of payments on a link probability of 1 payment Distribution of Link Weights (Number of Payments) ~ 60% Fedwire Banks: Directed-Strong Gross Largest Component 1st Quarter 2004 0 -1 probability of power law distribution, 10 payments Log10 of Probability -2 ~ 0.4% P(n)~n-2 -3 -4 -5 probability of 100 payments -6 ~ 0.005% -7 0 1 2 3 4 Log10 of Number of Payments Sent average = 5.1 13
  15. 15. Value of payments on a link Distribution of Edge Weights (Value) Fedwire Banks: Directed-Strong Gross Largest Component 1st Quarter 2004 .08 value of payments transacted on a link .06 Fraction of Edges follows a lognormal distribution .04 average = 15.2 mil. .02 0 -2 0 2 4 6 8 10 Log10 of Value Note: The curve is a normal distribution 14
  16. 16. Average Path Length how dense is the network? Histogram of Average Path Length Mass-Distance Function .1 Fedwire Banks: Directed-Strong Gross Largest Component 1st Quarter 2004 5000 Fraction of Nodes 4000 3000 M(d) .05 2000 1000 0 0 1 2 3 4 5 6 7 distance 0 2 3 4 5 6 Average Path Length Note: The curve is a normal distribution average path length 2.6 diameter (maximum) 7 15
  17. 17. Clustering how are banks connected locally? Histogram of Clustering Coefficient Example: .2 many real networks exhibit a high degree of clustering .15 Fraction of Nodes - internet 0.2-0.3 - co-authorship 0.6-0.8 = 3/6 = 0.5 .1 vs Erdos-Renyi 0.006 average .05 clustering coefficient = 0.53 0 0 .1 .2 .3 .4 .5 .6 .7 .8 .9 1 Clustering coefficient 16
  18. 18. Relevance of the numbers? • We don’t know yet. Some hypotheses: • Degree distribution and link weights (power law) – most banks irrelevant from financial stability perspective – hubs and bridges matter • Average path length – might be relevant for e.g. gridlocks RTGS systems. The smaller the APL, the quicker a liquidity shortage would spill over to other banks • Clustering co-efficient – might be relevant in contagion of netting systems, and in liquidity problems when exposures are reinforced by the neighbours 17
  19. 19. Summary • payment systems are just one of many similar networks • the statistics presented here are just scratch the surface • many questions ahead: – what drives the topology? – how does the topology relate to liquidity disturbances? – what is the topology of liquidity flows in other payment systems? – how to best describe the importance of a bank? (PageRank, betweenness centrality, etc) – other network statistics? (loops, communities, etc) 18
  20. 20. auxiliary slides 19
  21. 21. Other scale-free networks ... A B Sources: A) R. Albert and A.-L. Barabasi: Statistical mechanics of complex networks, Reviews of modern physics, vol. 74, January 2002 B) M. Boss, H. Elsinger, M. Summer, and S. Thurner: The Network Topology of the Interbank Market, Quantitative Finance, 4, 2004, 1-8. 20
  22. 22. Average nearest neighbour degree average Average Nearest Neighbor Out Degree degree of Fedwire Banks: Directed-Strong Gross Largest Component neighbours, 1st Quarter 2004 i.e. banks to 800 whom one • average = 617 has links to 600 • compare: average degree = 15 example: most banks have a very small degree, ANND degree 400 and connect to banks with high degree 50 200 10 15 5 0 ANND = (15+5+10+50) 0 500 1000 1500 2000 2500 Degree(k) /4 = 20 21
  23. 23. Link weights and degree Average Edge Weights (Number) by Out-Degree 20 15 Number 10 5 Average Edge Weights (Value) by Out-Degree 80 0 0 1 2 3 60 4 Log10 of Degree(k) Note: Degrees are binned log2 $bn 40 both the number and 20 value of payments on a link increase with the 0 degree of the bank 0 1 2 Log10 of Degree(k) 3 4 Note: Degrees are binned log2 22

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