Connectedness of Markets with Heterogeneous Agents and the Information Cascades

Macroeconomic integration of global financial markets is often characterized as complex systems where ever-increasing interactions among a vast number of agents make it difficult for the traditional economic theory to provide a realistic approximation of market dynamics. Economic systems are increasingly interdependent through cross-country networks of credit and investment, trade relations, or supply chains, and highlight the need for an integration of network theory and economic models to reduce the risk of global failure of financial systems. Our aim is to study the cross-holdings of entities in terms of input–output and look at a time-varying feature to examine the changes in the network. We also study the ripple effects caused due to the failure of entities inside the model. Using the World Input-Output Database (WIOD) dataset covering 28 countries from the European Union and 15 other major countries across 56 industries for the period from 2000 to 2014, we present evidence on the nature of interconnectedness that global markets exhibit in terms of their input–output representing the cross-holdings. The interdependence of some markets in a global network is strongly correlated with not only the size of the markets, but also the direction of trades/cross-holdings, and the type of industries that dominate in their input–output data. With growth model estimation, we are able to project the cascades of failures in the network significantly. Our findings employ innovative approaches such as network formation approach and graph theory to explain the interconnectedness of markets across the world, and contribute significantly to the theoretical issues related to market integration and risk spillover.