The Malta Financial Services Authority has congratulated two of its analysts after their paper developing a new way to model financial networks and analysing the effect of ‘herding behaviour’ among investment funds was featured on the European Systemic Risk Board’s website.
The European Systemic Risk Board was set up in 2010 in response to the global financial crisis to prevent and mitigate systemic risk. It is currently chaired by European Central Bank President Christine Lagarde.
The MFSA took to LinkedIn to congratulate the pair, saying: “Well done to Francesco Meglioli, PRM and Stephanie Gauci from the Financial Stability function who recently had a paper published on the European Systemic Risk Board website.”
Mr Meglioli, a Senior Analyst with the MFSA, also celebrated the occasion on the social network.
“Really glad to see the paper written by my colleague Stephanie Gauci and I published on the ESBR website,” he said.
He explained that the objective of the paper is twofold: “first we develop a new way to model networks when the entities have different levels of importance, then we analyse how herding behavior among investment funds impact the transmission of spillovers.”
Senior Analyst Francesco Meglioli
Mr Meglioli was also full of praise for Ms Gauci, who has been working with the Authority for three years as an Analyst.
“I take this chance to thank my amazing colleague Steph,” he said. “It is always an extremely enjoyable and fun experience to work with such a great and bright person!
“To know that the future of the Authority is in the hands of such talented young people like her should fill the MFSA with pride!”
Mr Meglioli closed by giving special thanks to the MFSA’s Head of Financial Stability Joseph Agius and Deputy Head of Financial Stability Tony Farrugia for their “endless support throughout the process”.
The paper
The paper sought to tweak prevailing models to present a new approach to analyse multi-level networks.
According to the paper, the methodology considers financial entities which, despite belonging to the same global financial network, may form part of different sub-networks in terms of relevance or geographical area.
“The main novelty of our methodology,” write Mr Meglioli and Ms Gauci, “is that it considers the presence of a ‘macro-level’ network and a ‘local-level’ network.”
They explain that “the ‘macro-level’ network is composed of various large indices whose developments influence the whole global network”, while “the ‘local-level’ network is composed of entities whose developments can impact the other entities in the same local network but are not important enough to influence the whole global network”.
The authors then use the new model to analyse spillovers between funds and financial markets, which could be especially relevant in the case where the latter are not particularly liquid, and in those market niches where funds play a dominant role.
“In the Maltese scenario,” they write, “where only few transactions occur in the stock exchange, if investment funds start receiving significant redemptions due to poor performance, the fund managers may need to sell off local equities and bonds to meet these redemptions, depressing prices in the Maltese financial markets.”
The methodology is therefore applied to study the financial stability implications of herding behaviour between domestic Maltese investment funds.
Mr Meglioli and Ms Gauci write: “The Maltese domestic investment funds industry is potentially susceptible to herding behaviour. One of the main reasons is that a handful of asset management companies are managing all the domestic funds. Therefore, it is likely that during a period of distress, a fund manager would take similar investment decisions across the different fund strategies that it manages.
“Moreover, due to most of the Maltese domestic investment funds being retail and the limited number of Maltese households, it is likely that managers will try to meet the investment preferences of the same pool of investors, thus adopting the same investment behaviour.”
The study confirms that when the herding behaviour in the domestic fund industry is stronger, the local financial market is more vulnerable to shocks in the domestic funds, as well as the domestic funds become more vulnerable to shocks in the financial markets.
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