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The dynamics of financial stability in complex networks

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  • Jo\~ao P. da Cruz
  • Pedro G. Lind
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    Abstract

    We address the problem of banking system resilience by applying off-equilibrium statistical physics to a system of particles, representing the economic agents, modelled according to the theoretical foundation of the current banking regulation, the so called Merton-Vasicek model. Economic agents are attracted to each other to exchange `economic energy', forming a network of trades. When the capital level of one economic agent drops below a minimum, the economic agent becomes insolvent. The insolvency of one single economic agent affects the economic energy of all its neighbours which thus become susceptible to insolvency, being able to trigger a chain of insolvencies (avalanche). We show that the distribution of avalanche sizes follows a power-law whose exponent depends on the minimum capital level. Furthermore, we present evidence that under an increase in the minimum capital level, large crashes will be avoided only if one assumes that agents will accept a drop in business levels, while keeping their trading attitudes and policies unchanged. The alternative assumption, that agents will try to restore their business levels, may lead to the unexpected consequence that large crises occur with higher probability.

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    File URL: http://arxiv.org/pdf/1103.0717
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1103.0717.

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    Date of creation: Mar 2011
    Date of revision: Jan 2013
    Publication status: Published in Eur. Phys. J. B (2012) 85: 256
    Handle: RePEc:arx:papers:1103.0717

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    1. Iori, Giulia & Jafarey, Saqib & Padilla, Francisco G., 2006. "Systemic risk on the interbank market," Journal of Economic Behavior & Organization, Elsevier, vol. 61(4), pages 525-542, December.
    2. Lux, T. & M. Marchesi, . "Scaling and Criticality in a Stochastic Multi-Agent Model of a Financial Market," Discussion Paper Serie B 438, University of Bonn, Germany, revised Jul 1998.
    3. Roberto Piazza, 2010. "Growth and Crisis, Unavoidable Connection?," IMF Working Papers 10/267, International Monetary Fund.
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