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An analysis of power law distributions and tipping points during the global financial crisis

Published online by Cambridge University Press:  26 February 2018

Yifei Li ,
Lei Shi ,
Neil Allan  and
John Evans
Yifei Li
Affiliation:
Sydney Business School, University of Wollongong, Macquarie Pl, Sydney, NSW 2000, Australia
Lei Shi
Affiliation:
Sydney Business School, University of Wollongong, Macquarie Pl, Sydney, NSW 2000, Australia
Neil Allan
Affiliation:
Systems Centre, Bristol University, 4 Bridge Yard, Bradford on Avon, Wiltshire, BA15 1EJ, UK
John Evans*
Affiliation:
Centre for Analysis of Complex Financial Systems, PO Box 363, Summer Hill, NSW 2130, Australia
*
*Correspondence to: John Evans, Centre for Analysis of Complex Financial Systems, PO Box 363, Summer Hill, NSW 2130, Australia. Tel: +61414643658; E-mail: [email protected]
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Abstract

Heavy-tailed distributions have been observed for various financial risks and papers have observed that these heavy-tailed distributions are power law distributions. The breakdown of a power law distribution is also seen as an indicator of a tipping point being reached and a system then moves from stability through instability to a new equilibrium. In this paper, we analyse the distribution of operational risk losses in US banks, credit defaults in US corporates and market risk events in the US during the global financial crisis (GFC). We conclude that market risk and credit risk do not follow a power law distribution, and even though operational risk follows a power law distribution, there is a better distribution fit for operational risk. We also conclude that whilst there is evidence that credit defaults and market risks did reach a tipping point, operational risk losses did not. We conclude that the government intervention in the banking system during the GFC was a possible cause of banks avoiding a tipping point.

Keywords

Global financial crisisPower law distributionTipping pointUS financial risks

JEL classification

G15: International Financial Markets G18: Government Policy and Regulation
Type
Paper
Information
Annals of Actuarial Science , Volume 13 , Issue 1 , March 2019 , pp. 80 - 91
Copyright
© Institute and Faculty of Actuaries 2018 

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