An Epidemiologic Approach of Financial Markets

The current financial crisis is comparable to a pandemic (an epidemic which has spread to the entire world). Diamond and Rajan warned that local bank failures could lead to a “contagion” (domino effect or knock-on defaults) and financial crisis showing astonishing resemblances to disease propagating like an epidemic.1 Both disease contagions and financial contagions are induced by one or a limited number of “infected” entities.2 In the case of disease contagions, the infected entity is an individual incubating a micro-organism (e.g., a virus or bacteria) who eventually spreads the infection to the community the individual is connected to. The entity, in the case of financial crisis, is a financial institution committing fraud, internal irregularities or facing losses due to risky loans and investments.3 The consequences of either an infectious disease pandemic or a financial crisis are dramatic, the former potentially leading to millions of deaths. The flu pandemic in 1918 was estimated to have killed between 50 and 100 million people in about six months, while the latter eventually resulted in millions of ruined shareholders and job losses.4 An additional consequence of both disease and financial epidemics is that the remaining sensitive individuals (non-infected) become suspicious toward other individuals, considering them as infected and refusing to enter relationships with them. Allen and Gale focused their work on claim emissions that occurred against suspected institutions or regions, with the consequence of value loss of this claim, potentially leading to contagion.5