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Financial crises and the evaporation of trust

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  • Kartik Anand
  • Prasanna Gai
  • Matteo Marsili

Abstract

Trust lies at the crux of most economic transactions, with credit markets being a notable example. Drawing on insights from the literature on coordination games and network growth, we develop a simple model to clarify how trust breaks down in financial systems. We show how the arrival of bad news about a financial agent can lead others to lose confidence in it and how this, in turn, can spread across the entire system. Our results emphasize the role of hysteresis -- it takes considerable effort to regain trust once it has been broken. Although simple, the model provides a plausible account of the credit freeze that followed the global financial crisis of 2007/8, both in terms of the sequence of events and the measures taken (and being proposed) by the authorities.

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Paper provided by arXiv.org in its series Papers with number 0911.3099.

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Date of creation: Nov 2009
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Handle: RePEc:arx:papers:0911.3099

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  1. Viral V. Acharya & Douglas Gale & Tanju Yorulmazer, 2011. "Rollover Risk and Market Freezes," Journal of Finance, American Finance Association, American Finance Association, vol. 66(4), pages 1177-1209, 08.
  2. Edward L. Glaeser & David I. Laibson & José A. Scheinkman & Christine L. Soutter, 2000. "Measuring Trust," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 115(3), pages 811-846, August.
    • Glaeser, Edward Ludwig & Laibson, David I. & Scheinkman, Jose A. & Soutter, Christine L., 2000. "Measuring Trust," Scholarly Articles 4481497, Harvard University Department of Economics.
  3. Ricardo J. Caballero & Alp Simsek, 2009. "Complexity and Financial Panics," NBER Working Papers 14997, National Bureau of Economic Research, Inc.
  4. Christian Upper, 2007. "Using counterfactual simulations to assess the danger of contagion in interbank markets," BIS Working Papers 234, Bank for International Settlements.
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Cited by:
  1. Czerniak, Adam, 2010. "Symptomy kryzysu globalnego a etyka gospodarcza religii światowych. Analiza porównawcza bankowości islamskiej i bankowości klasycznej w kontekście kryzysu finansowego
    [The differences between
    ," MPRA Paper 26971, University Library of Munich, Germany.
  2. Jean-Philippe Bouchaud, 2011. "Panel Statement: The endogenous dynamics of markets: price impact and feedback loops," Chapters, European Central Bank, European Central Bank.

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