The Scope of the Problem

Financial reform in the US has led to the creation of a new federal body charged with identifying and regulating systemic risk. One key tool that has been proposed for use by this regulatory body is a network model of the financial system.

Network models have been applied in other areas, notably in communications, transportation, and electric power distribution. In each of these areas, some item flows from point to point through a network that involves connections between points. In the financial system there is interest in the flow of cash and credit between financial institutions. The points on the network are institutions, and the connections are counterparty relationships such as debtor, creditor, investor, or derivative counterparty.

The goal of this research project is to outline options for the design of a network model of the financial system, for potential use by the new federal regulatory body. The project has three phases:

Phase I: Scan the literature concerning the practical application of network models and develop an annotated bibliography.

Phase II: Outline options for the design of a network model of the financial system for potential use by the federal regulatory body. The outline would take the form of a paper suitable for publishing, and would include discussion of the following aspects of a network model.

• The characteristics of each point or node on the network. Each node represents a financial institution, with characteristics such as type of business (banking, insurance, etc), size, leverage, liquidity, and use of short term credit.
• The characteristics of connections between nodes. Connections would represent counterparty relationships involving financing, investments, derivatives, customers, suppliers, and so on. The node structure should also include a representation of clearing corporations as they are envisioned under Dodd-Frank, since these structures will contribute to systemic counterparty exposure.
• The data that would be needed and its availability to quantify the characteristics of nodes and connections. The research team should consult with the Committee to Establish the National Institute of Finance, an organization focused on collection of data needed for monitoring systemic risk, when assembling data requirements.
• The way in which data regarding the characteristics of the nodes and connections could be used to determine the effect of node failure, e.g. the effect of removing a node from the network. The effect would, due to connections to other nodes, radiate through the network, thereby changing its overall state. Ideally, this effect on the entire network could be expressed quantitatively, perhaps in terms of capacity or quantity of flow along the connections. Note that a quantitative measure is desired to identify systemically important nodes (i.e. systemically important financial institutions) for regulatory attention.

Phase III: Create a software implementation of a network model, with several sets of sample data concerning nodes and connections. The software would be used to illustrate the effect of different networks, such as one with just a few large institutions, one with many small institutions, and one with a mixture of large and small institutions. The software should be open-source in nature so that other researchers (or potentially regulators) could modify or extend it for further studies.

To facilitate the evaluation of proposals, the following information should be submitted:

1. Resumes of the authors, including any graduate student(s) expected to participate, indicating how their background, education, and experience bear on their qualifications to undertake the research. If more than one author is involved for each report, a single individual should be designated as the lead researcher and primary contact. The person submitting the proposal must be authorized to speak on behalf of all the authors as well as for the firm or institution on whose behalf the proposal is submitted.
2. A description of the data to be used.
3. A description the expected report and any supporting data, tools or other resources.
4. Cost estimates for the research, including computer time, salaries, report preparation, research costs, etc. Such estimates can be in the form of hourly rates, but in such cases, time estimates should also be included. Any guarantees as to total cost should be given and will be considered in the evaluation of the proposal. While cost will be a factor in the evaluation of the proposal, it will not necessarily be the decisive factor.
5. A schedule for completion of the research, identifying key dates or time frames for research completion and report submission.
6. Other related factors that give evidence of a proposer's capabilities to perform in a superior fashion should be detailed.

The CAS, CIA, and SOA Joint Risk Management Section is responsible for the selection of the proposal to be funded. Input from other knowledgeable individuals may also be sought, but the CAS, CIA, and SOA Joint Risk Management Section will make the final decision. The SOA's Research Actuary will provide staff actuarial support. A Project Oversight Group (POG) will be appointed to oversee the project upon selection of the proposal.

Any questions regarding this RFP should be directed to:

Steven Siegel, SOA Research Actuary
ssiegel@soa.org
ph: 847.706.3578
f: 847.273.8578

If you intend to submit a proposal, please e-mail written notificationby October 15, 2011 to:

Barbara Scott, SOA Research Administrator
bscott@soa.org
f: 847.273.8592

Please email a copy of the proposal to Barbara Scott at bscott@soa.org

Proposals must be received no later than November 1, 2011. It is anticipated that all authors who have submitted proposals will be informed of the status of their proposal no later than December 2011.

Note: Proposals are considered confidential and proprietary.

The CAS, CIA, and SOA Joint Risk Management Section reserves the right to not award a contract for this research. Reasons for not awarding a contract could include, but are not limited to, a lack of acceptable proposals or a finding that insufficient funds are available. The CAS, CIA, and SOA Joint Risk Management Section also reserves the right to redirect the project as is deemed advisable.

The CAS, CIA, and SOA Joint Risk Management Section intends to copyright and publish the results of this research. The research will be considered work-for-hire and all rights thereto belong to the organizations. However, appropriate credit will be given to the researcher(s).