The Unified Framework for Modelling Credit Cycles with Marshall-Walras Price Formation Process And Systemic Risk Assessment

Paper: arXiv 2305.06337

Authors: Kamil Fortuna, Janusz Szwabiński

Abstract

Systemic risk is a rapidly developing area of research. Classical financial models often do not adequately reflect the phenomena of bubbles, crises, and transitions between them during credit cycles. To study very improbable events, systemic risk methodologies utilise advanced mathematical and computational tools, such as complex systems, chaos theory, and Monte Carlo simulations. In this paper, a relatively simple mathematical formalism is applied to provide a unified framework for modeling credit cycles and systemic risk assessment. The proposed model is analyzed in detail to assess whether it can reflect very different states of the economy. Basing on those results, measures of systemic risk are constructed to provide information regarding the stability of the system. The formalism is then applied to describe the full credit cycle with the explanation of causal relationships between the phases expressed in terms of parameters derived from real-world quantities. The framework can be naturally interpreted and understood with respect to different economic situations and easily incorporated into the analysis and decision-making process based on classical models, significantly enhancing their quality and flexibility.

Complexity vs Empirical Score

• Math Complexity: 6.5/10
• Empirical Rigor: 3.0/10
• Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper introduces a novel theoretical framework unifying credit cycles and price formation through Marshall-Walras processes and dynamical systems. However, it relies heavily on theoretical formulations and lacks rigorous empirical backtesting or real-world dataset validation.

Research Flowchart

  flowchart TD
    A[Goal: Unified Framework for Credit Cycles & Systemic Risk Assessment] --> B[Data Inputs: Real-World Economic Quantities & Classical Financial Models]
    B --> C[Methodology: Simple Mathematical Formalism with Marshall-Walras Price Formation]
    C --> D[Computational Processes: Complex Systems, Chaos Theory & Monte Carlo Simulations]
    D --> E[Analysis: Model Credit Cycle Phases & Causal Relationships]
    E --> F[Outcomes: Systemic Risk Stability Measures & Enhanced Decision-Making Framework]