TITLE:
Dynamic Structure of the Global Financial System of Systems
AUTHORS:
Khaldoun Khashanah, Yue Li
KEYWORDS:
Principal Components Analysis (PCA), Minimum Spanning Tree (MST), Financial Systems, System of Systems (SoS), Systemic Risk
JOURNAL NAME:
Modern Economy,
Vol.7 No.11,
October
20,
2016
ABSTRACT: Purpose: This paper empirically investigates the structural evolution of global
financial systems from the system of systems (SoS) view for eleven countries.
The financial SoS consists of eleven countries each of which has its own
financial system with relative autonomy. The paper aims to provide a prototype
of the structural dynamics of the global financial SoS for the eleven financial
entities during different phases of the financial markets. Methodology/Approach: The graph-theoretic approach of minimum spanning trees (MST) is applied on two
levels to construct the component level of a subsystem within each country and
the systemic level of global financial SoS. An SoS can be viewed as a network
of networks (NoN) of financial transactions. The statistical approach of
principal components analysis (PCA) is also applied to the systemic level of
financial SoS among geographic countries to find the driving factor of
variance. Originality/Value: This study provides an empirical
quantitative measure of systemic risk and applies it to the global SoS to
describe the interconnections and linkages. This paper examines the transmission
of risks among the components. The structural dynamics of the SoS is expected
to be a function of economic cycles including episodes of economic expansion
and contraction. Findings: The average distance of component level MST
is found to be lower during an economic contraction and higher during an
economic expansion. The systemic level MST of global SoS can successfully
reflect the geographic as well as the economic relationship between countries.
The model verifies the intuition on natural clusters of Germany-France-Italy
and the USA-Canada-UK as implied by the tight economic interconnections in each
cluster. The result from PCA shows the USA, UK, and Australia experienced a
counter movement compared to other European countries during the Euro debt
crisis. The Japan financial system contraction and expansion can be explained
by other countries indicating that it does not appear to be the driving factor
of global SoS over the period of the data sample.