Measuring Financial Systemic Risk: Net Liability Clearing Mechanism and Contagion Effect

Following the framework of E-N model (Eisenberg and Noe, 2001), the authors consider a new clearing mechanism based on net liabilities among financial institutions since the liabilities between the counterparties should be deducted accordingly when clearing in practice. As the basis for systemic risk measurement, similar to the original E-N model, the authors first establish some good properties for the clearing payment vector according to a more general model. Then, the authors investigate how risk spreads among institutions through the liability network forming the risk contagion channel. Finally, the authors illustrate with a specific example that the original E-N clearing mechanism may misidentify the systemic important institutions, and theoretically show that it may also overestimate the risk compared with the netting clearing mechanism.