Kimmo Soramäki - Academia.edu (original) (raw)
Papers by Kimmo Soramäki
and bank failures in large value payment systems
Physica A: Statistical Mechanics and its Applications, 2007
We develop a parsimonious model of the interbank payment system to study congestion and the role ... more We develop a parsimonious model of the interbank payment system to study congestion and the role of liquidity markets in alleviating congestion. The model incorporates an endogenous instruction arrival process, scale-free topology of payments between banks, fixed total liquidity that limits banks' capacity to process arriving instructions, and a global market that distributes liquidity. We find that at low liquidity, the system becomes congested and payment settlement loses correlation with payment instruction arrival, becoming coupled across the network. The onset of congestion is evidently related to the relative values of three characteristic times: the time for banks' net position to return to zero, the time for banks to exhaust their liquidity endowments, and the liquidity market relaxation time. In the congested regime, settlement takes place in cascades having a characteristic size. A global liquidity market substantially diminishes congestion, requiring only a small fraction of the payment-induced liquidity flow to achieve strong beneficial effects.
SSRN Electronic Journal, 2016
Through financial network analysis we ascertain the existence of important causal behavior among ... more Through financial network analysis we ascertain the existence of important causal behavior among certain financial assets, as inferred by eight different causality methods. Our results contradict the Efficient Market Hypothesis and open new horizons for further investigation and possible arbitrage opportunities. Moreover, we find some evidence that two of the causality methods used, at least to some extent, could warn us about the financial crisis of 2007-2009. Furthermore, we test the similarity percentage of the eight causality methods and we find that the most similar pair of causality-induced networks is on average less than 50% similar throughout the time period examined, rendering thus the comparability and substitutability among those causality methods rather dubious. We also rank both the causal relationships and the assets in terms of overall causality exertion and we find that there is an underlying bonds regime almost monopolising in some cases the realm of causality. Finally, we observe a recurring pattern of Oil's rising role as the financial network faces the Chinese stock market crash.
We lay out and simulate a multi-agent, multi-period model of an RTGS payment system. At the begin... more We lay out and simulate a multi-agent, multi-period model of an RTGS payment system. At the beginning of the day, banks choose how much costly liquidity to allocate to the settlement process. Then, they use it to execute an exogenous, random stream of payment orders. If a bank’s liquidity stock is depleted, payments are queued until new liquidity arrives from other banks, imposing costs on the delaying bank. We study the equilibrium level of liquidity posted in the system, performing some comparative statics and obtaining: i) a liquidity demand curve which links liquidity to delay costs; ii) insights on the efficiency of alternative system configurations; iii) insights on the effects of operational incidents on the amount of liquidity present in the system. † Bank of England.
This paper analyses liquidity and credit risks in the context of interdependent interbank payment... more This paper analyses liquidity and credit risks in the context of interdependent interbank payment systems. We develop a simple model to investigate the operation of two real time gross settlement systems interlinked through foreign exchange transactions conducted by a set of global banks. Further interdependence is created by a Payment versus Payment (PvP) constraint that links the two legs of the foreign exchange transactions. The model illustrates under which conditions settlement of payments in the two systems becomes correlated and how large credit exposures can be generated as the result of liquidity pressures in one of the two systems. PvP can eliminate this credit risk but will create a new interdependence by making settlement of payments in both systems dependent on the level of liquidity available in the other system.
Aalto University, P.O. Box 11000, FI-00076 Aalto www.aalto.fi Author Kimmo Soramaki Name of the d... more Aalto University, P.O. Box 11000, FI-00076 Aalto www.aalto.fi Author Kimmo Soramaki Name of the doctoral dissertation Network Topology, System Mechanics and Behavioral Dynamics in Interbank Payment Systems Publisher Aalto University School of Science Unit Mathematics and Systems Analysis Series Aalto University publication series DOCTORAL DISSERTATIONS 75/2012 Field of research Systems and Operations Research Manuscript submitted 15 February 2012 Manuscript revised 15 February 2012 Date of the defence 6 June 2012 Language English Monograph Article dissertation (summary + original articles) Abstract The financial crisis of 2007-09 showed that financial institutions are highly interconnected and that the dynamic behavior of complex financial systems is hard to foresee. This Dissertation applies and develops new quantitative methods that describe the interbank payment functions of the financial system, both during normal circumstances and during times of crisis. First, it describes the...
During the last few decades, most industrialised countries have introduced real-time gross settle... more During the last few decades, most industrialised countries have introduced real-time gross settlement (RTGS) systems for the settlement of large, timecritical interbank payments. In RTGS systems, payments are settled continuously and individually in real time during the day and payments are only made if the funds on the settlement account are sufficient. Settlement in RTGS systems carries no credit risk and thus a low level of systemic risks. The reduction in these risks is however traded against increased liquidity requirements and thereby increased liquidity risk. The liquidity risks can be significant because of the pivotal role of these systems in the economy, and due to the high value transferred in these systems.
ArXiv, 2007
We develop a dynamic multi-agent model of an interbank payment system where banks choose their le... more We develop a dynamic multi-agent model of an interbank payment system where banks choose their level of available funds on the basis of private payoff maximisation. The model consists of the repetition of a simultaneous move stage game with incomplete information, incomplete monitoring, and stochastic payoffs. Adaptation takes place with bayesian updating, with banks maximizing immediate payoffs. We carry out numerical simulations to solve the model and investigate two special scenarios: an operational incident and exogenous throughput guidelines for payment submission. We find that the demand for intraday credit is an S-shaped function of the cost ratio between intraday credit costs and the costs associated with delaying payments. We also find that the demand for liquidity is increased both under operational incidents and in the presence of effective throughput guidelines.
In this study three topics in particular are analysed.First, the adequacy of intraday credit limi... more In this study three topics in particular are analysed.First, the adequacy of intraday credit limits in the existing and planned Finnish interbank funds transfers systems are studied.Secondly, the efficiency of two actual and two hypothetical payment settlement systems is analysed and, thirdly, the effects of optimization features such as queuing, payment splitting and netting of queued transfers are examined. The data used in the study consist of four days of actual payment data provided by the major banks operating in Finland and 100 days of generated data, where the order and number of daily payments is varied.The study is based on results generated by a payment systems simulator that was developed at the Bank of Finland.The simulator is capable of simulating a wide variety of hypothetical settlement and banking structures as well as various optimization features. The results show that the existing intraday credit limits of the Finnish banks will be sufficient in the settlement sy...
We develop a model of two-sided markets that illustrates the role of bargaining power between the... more We develop a model of two-sided markets that illustrates the role of bargaining power between the two sides of the market. We are interested in the profit maximizing usage fees set by identical duopolistic platforms which engage in homogeneous, Bertrand-type competition. We find that for a sufficiently low marginal cost duopolistic two-sided competition reduces to a grab-the-dollar game with two asymmetric (pure) Nash equilibria. These equilibria are characterized by highly skewed prices, in which the side with all the bargaining power pays a minimum price. The other side of the market is used for cross-subsidization and is charged a high price. Compared to the monopoly outcome, competition lowers the total price charged to both sides, although the seller's equilibrium price may exceed the monopoly price. Both platforms enjoy excess profits.Key Words: platform competition, bargaining power, asymmetric equilibria, skewed pricing
The paper analyses the severity of gridlocks in interbank payment systems operating on a real tim... more The paper analyses the severity of gridlocks in interbank payment systems operating on a real time basis and evaluates by means of simulations the merits of a gridlock resolution algorithm. Data used in the simulations consist of actual payments settled in the Danish and Finnish RTGS systems. The algorithm is found to be applicable to a real time environment and effective in reducing queuing in the systems at all levels of liquidity, but in particular when intra-day liquidity is scarce.
lobalization and technological innovation are two of the most pervasive forces affecting the fina... more lobalization and technological innovation are two of the most pervasive forces affecting the financial system and its infrastructure. Perhaps nowhere are these trends more apparent than in the internationalization and automation of payments. The evolving landscape is most obvious in retail payments. The use of paper checks is in rapid decline or has been eliminated in most of the industrialized world. Credit and debit cards can be used in the most surprising places. Internet banking with money transfer capabilities is common, and several providers are competing to service consumers’ payments over the Internet and mobile devices. In wholesale, or interbank, payments, the effect of globalization and technological innovation is probably less obvious to the casual observer—but it has been equally impressive. Given the importance of payments and settlement systems to the smooth operation as well as resiliency of the financial system, stakeholders need to understand and assess the potenti...
This paper analyses liquidity and credit risks in t he context of interdependent interbank paymen... more This paper analyses liquidity and credit risks in t he context of interdependent interbank payment systems. A simple model is developed to investigate the operation of two real time gross settlement systems interlinked through FX transacti ons conducted by a set of global banks that participate in both systems. In addition, further i nterdependence is created by imposing a Payment versus Payment (PvP) constraint. The model illustrates under which conditions settlement of payments in the two systems becomes c orrelated and how credit exposures are created as the result of liquidity pressures in one of the two systems. PvP can eliminate this credit risk but will make the settlement process of each system dependent on the level of liquidity available in the other system. The consequences of an perational disruption affecting a bank participating in only one system are investigated. The crisis is shown to spread to the other system with different consequences depending on the level of l...
This paper analyses liquidity and credit risks in t he context of interdependent interbank paymen... more This paper analyses liquidity and credit risks in t he context of interdependent interbank payment systems. A simple model is developed to investigate the operation of two real time gross settlement systems interlinked through FX transacti ons conducted by a set of global banks that participate in both systems. In addition, further iis created by imposing a Payment versus Payment (PvP) constraint. The model illustrates under which conditions settlement of payments in the two systems becomes cand how large credit exposures can be generated as the result of liquidity pressur es in one of the two systems. PvP can eliminate this credit risk but will make each system dependen t on the level of liquidity available in the other system.
This chapter introduces the concept of financial networks and reviews research in three of the mo... more This chapter introduces the concept of financial networks and reviews research in three of the most active research areas of financial systems: interbank payment networks, interbank exposure networks, and asset correlation networks. The financial crisis of 2007-2008 revealed the intertwined nature of modern financial systems. A promising methodology for capturing and modeling connections in the financial system is provided by network theory. The intricate structure of linkages between financial institutions, among sectors of the economy, and across financial systems can conveniently be captured by using a network representation. Empirical research on describing existing networks is presented, as well as new modeling and simulation approaches for financial risk that take into account the complex structure of financial markets and infrastructures.
and bank failures in large value payment systems
Physica A: Statistical Mechanics and its Applications, 2007
We develop a parsimonious model of the interbank payment system to study congestion and the role ... more We develop a parsimonious model of the interbank payment system to study congestion and the role of liquidity markets in alleviating congestion. The model incorporates an endogenous instruction arrival process, scale-free topology of payments between banks, fixed total liquidity that limits banks' capacity to process arriving instructions, and a global market that distributes liquidity. We find that at low liquidity, the system becomes congested and payment settlement loses correlation with payment instruction arrival, becoming coupled across the network. The onset of congestion is evidently related to the relative values of three characteristic times: the time for banks' net position to return to zero, the time for banks to exhaust their liquidity endowments, and the liquidity market relaxation time. In the congested regime, settlement takes place in cascades having a characteristic size. A global liquidity market substantially diminishes congestion, requiring only a small fraction of the payment-induced liquidity flow to achieve strong beneficial effects.
SSRN Electronic Journal, 2016
Through financial network analysis we ascertain the existence of important causal behavior among ... more Through financial network analysis we ascertain the existence of important causal behavior among certain financial assets, as inferred by eight different causality methods. Our results contradict the Efficient Market Hypothesis and open new horizons for further investigation and possible arbitrage opportunities. Moreover, we find some evidence that two of the causality methods used, at least to some extent, could warn us about the financial crisis of 2007-2009. Furthermore, we test the similarity percentage of the eight causality methods and we find that the most similar pair of causality-induced networks is on average less than 50% similar throughout the time period examined, rendering thus the comparability and substitutability among those causality methods rather dubious. We also rank both the causal relationships and the assets in terms of overall causality exertion and we find that there is an underlying bonds regime almost monopolising in some cases the realm of causality. Finally, we observe a recurring pattern of Oil's rising role as the financial network faces the Chinese stock market crash.
We lay out and simulate a multi-agent, multi-period model of an RTGS payment system. At the begin... more We lay out and simulate a multi-agent, multi-period model of an RTGS payment system. At the beginning of the day, banks choose how much costly liquidity to allocate to the settlement process. Then, they use it to execute an exogenous, random stream of payment orders. If a bank’s liquidity stock is depleted, payments are queued until new liquidity arrives from other banks, imposing costs on the delaying bank. We study the equilibrium level of liquidity posted in the system, performing some comparative statics and obtaining: i) a liquidity demand curve which links liquidity to delay costs; ii) insights on the efficiency of alternative system configurations; iii) insights on the effects of operational incidents on the amount of liquidity present in the system. † Bank of England.
This paper analyses liquidity and credit risks in the context of interdependent interbank payment... more This paper analyses liquidity and credit risks in the context of interdependent interbank payment systems. We develop a simple model to investigate the operation of two real time gross settlement systems interlinked through foreign exchange transactions conducted by a set of global banks. Further interdependence is created by a Payment versus Payment (PvP) constraint that links the two legs of the foreign exchange transactions. The model illustrates under which conditions settlement of payments in the two systems becomes correlated and how large credit exposures can be generated as the result of liquidity pressures in one of the two systems. PvP can eliminate this credit risk but will create a new interdependence by making settlement of payments in both systems dependent on the level of liquidity available in the other system.
Aalto University, P.O. Box 11000, FI-00076 Aalto www.aalto.fi Author Kimmo Soramaki Name of the d... more Aalto University, P.O. Box 11000, FI-00076 Aalto www.aalto.fi Author Kimmo Soramaki Name of the doctoral dissertation Network Topology, System Mechanics and Behavioral Dynamics in Interbank Payment Systems Publisher Aalto University School of Science Unit Mathematics and Systems Analysis Series Aalto University publication series DOCTORAL DISSERTATIONS 75/2012 Field of research Systems and Operations Research Manuscript submitted 15 February 2012 Manuscript revised 15 February 2012 Date of the defence 6 June 2012 Language English Monograph Article dissertation (summary + original articles) Abstract The financial crisis of 2007-09 showed that financial institutions are highly interconnected and that the dynamic behavior of complex financial systems is hard to foresee. This Dissertation applies and develops new quantitative methods that describe the interbank payment functions of the financial system, both during normal circumstances and during times of crisis. First, it describes the...
During the last few decades, most industrialised countries have introduced real-time gross settle... more During the last few decades, most industrialised countries have introduced real-time gross settlement (RTGS) systems for the settlement of large, timecritical interbank payments. In RTGS systems, payments are settled continuously and individually in real time during the day and payments are only made if the funds on the settlement account are sufficient. Settlement in RTGS systems carries no credit risk and thus a low level of systemic risks. The reduction in these risks is however traded against increased liquidity requirements and thereby increased liquidity risk. The liquidity risks can be significant because of the pivotal role of these systems in the economy, and due to the high value transferred in these systems.
ArXiv, 2007
We develop a dynamic multi-agent model of an interbank payment system where banks choose their le... more We develop a dynamic multi-agent model of an interbank payment system where banks choose their level of available funds on the basis of private payoff maximisation. The model consists of the repetition of a simultaneous move stage game with incomplete information, incomplete monitoring, and stochastic payoffs. Adaptation takes place with bayesian updating, with banks maximizing immediate payoffs. We carry out numerical simulations to solve the model and investigate two special scenarios: an operational incident and exogenous throughput guidelines for payment submission. We find that the demand for intraday credit is an S-shaped function of the cost ratio between intraday credit costs and the costs associated with delaying payments. We also find that the demand for liquidity is increased both under operational incidents and in the presence of effective throughput guidelines.
In this study three topics in particular are analysed.First, the adequacy of intraday credit limi... more In this study three topics in particular are analysed.First, the adequacy of intraday credit limits in the existing and planned Finnish interbank funds transfers systems are studied.Secondly, the efficiency of two actual and two hypothetical payment settlement systems is analysed and, thirdly, the effects of optimization features such as queuing, payment splitting and netting of queued transfers are examined. The data used in the study consist of four days of actual payment data provided by the major banks operating in Finland and 100 days of generated data, where the order and number of daily payments is varied.The study is based on results generated by a payment systems simulator that was developed at the Bank of Finland.The simulator is capable of simulating a wide variety of hypothetical settlement and banking structures as well as various optimization features. The results show that the existing intraday credit limits of the Finnish banks will be sufficient in the settlement sy...
We develop a model of two-sided markets that illustrates the role of bargaining power between the... more We develop a model of two-sided markets that illustrates the role of bargaining power between the two sides of the market. We are interested in the profit maximizing usage fees set by identical duopolistic platforms which engage in homogeneous, Bertrand-type competition. We find that for a sufficiently low marginal cost duopolistic two-sided competition reduces to a grab-the-dollar game with two asymmetric (pure) Nash equilibria. These equilibria are characterized by highly skewed prices, in which the side with all the bargaining power pays a minimum price. The other side of the market is used for cross-subsidization and is charged a high price. Compared to the monopoly outcome, competition lowers the total price charged to both sides, although the seller's equilibrium price may exceed the monopoly price. Both platforms enjoy excess profits.Key Words: platform competition, bargaining power, asymmetric equilibria, skewed pricing
The paper analyses the severity of gridlocks in interbank payment systems operating on a real tim... more The paper analyses the severity of gridlocks in interbank payment systems operating on a real time basis and evaluates by means of simulations the merits of a gridlock resolution algorithm. Data used in the simulations consist of actual payments settled in the Danish and Finnish RTGS systems. The algorithm is found to be applicable to a real time environment and effective in reducing queuing in the systems at all levels of liquidity, but in particular when intra-day liquidity is scarce.
lobalization and technological innovation are two of the most pervasive forces affecting the fina... more lobalization and technological innovation are two of the most pervasive forces affecting the financial system and its infrastructure. Perhaps nowhere are these trends more apparent than in the internationalization and automation of payments. The evolving landscape is most obvious in retail payments. The use of paper checks is in rapid decline or has been eliminated in most of the industrialized world. Credit and debit cards can be used in the most surprising places. Internet banking with money transfer capabilities is common, and several providers are competing to service consumers’ payments over the Internet and mobile devices. In wholesale, or interbank, payments, the effect of globalization and technological innovation is probably less obvious to the casual observer—but it has been equally impressive. Given the importance of payments and settlement systems to the smooth operation as well as resiliency of the financial system, stakeholders need to understand and assess the potenti...
This paper analyses liquidity and credit risks in t he context of interdependent interbank paymen... more This paper analyses liquidity and credit risks in t he context of interdependent interbank payment systems. A simple model is developed to investigate the operation of two real time gross settlement systems interlinked through FX transacti ons conducted by a set of global banks that participate in both systems. In addition, further i nterdependence is created by imposing a Payment versus Payment (PvP) constraint. The model illustrates under which conditions settlement of payments in the two systems becomes c orrelated and how credit exposures are created as the result of liquidity pressures in one of the two systems. PvP can eliminate this credit risk but will make the settlement process of each system dependent on the level of liquidity available in the other system. The consequences of an perational disruption affecting a bank participating in only one system are investigated. The crisis is shown to spread to the other system with different consequences depending on the level of l...
This paper analyses liquidity and credit risks in t he context of interdependent interbank paymen... more This paper analyses liquidity and credit risks in t he context of interdependent interbank payment systems. A simple model is developed to investigate the operation of two real time gross settlement systems interlinked through FX transacti ons conducted by a set of global banks that participate in both systems. In addition, further iis created by imposing a Payment versus Payment (PvP) constraint. The model illustrates under which conditions settlement of payments in the two systems becomes cand how large credit exposures can be generated as the result of liquidity pressur es in one of the two systems. PvP can eliminate this credit risk but will make each system dependen t on the level of liquidity available in the other system.
This chapter introduces the concept of financial networks and reviews research in three of the mo... more This chapter introduces the concept of financial networks and reviews research in three of the most active research areas of financial systems: interbank payment networks, interbank exposure networks, and asset correlation networks. The financial crisis of 2007-2008 revealed the intertwined nature of modern financial systems. A promising methodology for capturing and modeling connections in the financial system is provided by network theory. The intricate structure of linkages between financial institutions, among sectors of the economy, and across financial systems can conveniently be captured by using a network representation. Empirical research on describing existing networks is presented, as well as new modeling and simulation approaches for financial risk that take into account the complex structure of financial markets and infrastructures.