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Mapping Financial Stability

Peter Sarlin, Mapping Financial Stability. TUCS Dissertations 159. Åbo Akademi University, 2013.

Abstract:

The ongoing global financial crisis has demonstrated the importance of a systemwide, or macroprudential, approach to safeguarding financial stability. An essential part of macroprudential oversight concerns the tasks of early identification and assessment of risks and vulnerabilities that eventually may lead to a systemic financial crisis. Thriving tools are crucial as they allow early policy actions to decrease or prevent further build-up of risks or to otherwise enhance the shock absorption capacity of the financial system. In the literature, three types of systemic risk can be identified: i) build-up of widespread imbalances, ii) exogenous aggregate shocks, and iii) contagion. Accordingly, the systemic risks are matched by three categories of analytical methods for decision support: i) early-warning, ii) macro stress-testing, and iii) contagion models. Stimulated by the prolonged global financial crisis, today's toolbox of analytical methods includes a wide range of innovative solutions to the two tasks of risk identification and risk assessment. Yet, the literature lacks a focus on the task of risk communication.

This thesis discusses macroprudential oversight from the viewpoint of all three tasks: Within analytical tools for risk identification and risk assessment, the focus concerns a tight integration of means for risk communication. Data and dimension reduction methods, and their combinations, hold promise for representing multivariate data structures in easily understandable formats. The overall task of this thesis is to represent high-dimensional data concerning financial entities on lowdimensional displays. The low-dimensional representations have two subtasks: i) to function as a display for individual data concerning entities and their time series, and ii) to use the display as a basis to which additional information can be linked. The final nuance of the task is, however, set by the needs of the domain, data and methods. The following ve questions comprise subsequent steps addressed in the process of this thesis:

1. What are the needs for macroprudential oversight?
2. What form do macroprudential data take?
3. Which data and dimension reduction methods hold most promise for the task?
4. How should the methods be extended and enhanced for the task?
5. How should the methods and their extensions be applied to the task?

Based upon the Self-Organizing Map (SOM), this thesis not only creates the Self-Organizing Financial Stability Map (SOFSM), but also lays out a general framework for mapping the state of financial stability. This thesis also introduces three extensions to the standard SOM for enhancing the visualization and extraction of information: i) fuzzifications, ii) transition probabilities, and iii) network analysis. Thus, the SOFSM functions as a display for risk identification, on top of which risk assessments can be illustrated. In addition, this thesis puts forward the Self-Organizing Time Map (SOTM) to provide means for visual dynamic clustering, which in the context of macroprudential oversight concerns the identification of cross-sectional changes in risks and vulnerabilities over time. Rather than automated analysis, the aim of visual means for identifying and assessing risks is to support disciplined and structured judgmental analysis based upon policymakers' experience and domain intelligence, as well as external risk communication.

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BibTeX entry:

@PHDTHESIS{phdSarlin_Peter13a,
  title = {Mapping Financial Stability},
  author = {Sarlin, Peter},
  number = {159},
  series = {TUCS Dissertations},
  school = {Åbo Akademi University},
  year = {2013},
  ISBN = {978-952-12-2890-2},
}

Belongs to TUCS Research Unit(s): Data Mining and Knowledge Management Laboratory

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