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The Lehman Brothers Effect and Bankruptcy Cascades


  • Pawe{l} Sieczka
  • Didier Sornette
  • Janusz A. Ho{l}yst


Inspired by the bankruptcy of Lehman Brothers and its consequences on the global financial system, we develop a simple model in which the Lehman default event is quantified as having an almost immediate effect in worsening the credit worthiness of all financial institutions in the economic network. In our stylized description, all properties of a given firm are captured by its effective credit rating, which follows a simple dynamics of co-evolution with the credit ratings of the other firms in our economic network. The dynamics resembles the evolution of Potts spin-glass with external global field corresponding to a panic effect in the economy. The existence of a global phase transition, between paramagnetic and ferromagnetic phases, explains the large susceptibility of the system to negative shocks. We show that bailing out the first few defaulting firms does not solve the problem, but does have the effect of alleviating considerably the global shock, as measured by the fraction of firms that are not defaulting as a consequence. This beneficial effect is the counterpart of the large vulnerability of the system of coupled firms, which are both the direct consequences of the collective self-organized endogenous behaviors of the credit ratings of the firms in our economic network.

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  • Pawe{l} Sieczka & Didier Sornette & Janusz A. Ho{l}yst, 2010. "The Lehman Brothers Effect and Bankruptcy Cascades," Papers 1002.1070,, revised Sep 2011.
  • Handle: RePEc:arx:papers:1002.1070

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    References listed on IDEAS

    1. P. Sieczka & J. A. Hołyst, 2009. "Collective firm bankruptcies and phase transition in rating dynamics," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 71(4), pages 461-466, October.
    2. Domenico Delli Gatti & Mauro Gallegati & Bruce C. Greenwald & Alberto Russo & Joseph E. Stiglitz, 2008. "Financially Constrained Fluctuations in an Evolving Network Economy," NBER Working Papers 14112, National Bureau of Economic Research, Inc.
    3. Frank Schweitzer & Giorgio Fagiolo & Didier Sornette & Fernando Vega-Redondo & Douglas R. White, 2009. "Economic Networks: What Do We Know And What Do We Need To Know?," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 12(04n05), pages 407-422.
    4. Pawe{l} Sieczka & Janusz A. Ho{l}yst, 2009. "Collective firm bankruptcies and phase transition in rating dynamics," Papers 0904.4430,, revised Sep 2009.
    5. Giesecke, Kay, 2004. "Correlated default with incomplete information," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1521-1545, July.
    6. D. Sornette, 2000. "Stock Market Speculation: Spontaneous Symmetry Breaking of Economic Valuation," Papers cond-mat/0004001,
    7. Neu, Peter & Kühn, Reimer, 2004. "Credit risk enhancement in a network of interdependent firms," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 342(3), pages 639-655.
    8. Sornette, Didier, 2000. "Stock market speculation: Spontaneous symmetry breaking of economic valuation," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 284(1), pages 355-375.
    9. Kartik Anand & Reimer Kuhn, 2006. "Phase Transitions in Operational Risk," Papers physics/0609130,, revised Dec 2006.
    10. Battiston, Stefano & Delli Gatti, Domenico & Gallegati, Mauro & Greenwald, Bruce & Stiglitz, Joseph E., 2007. "Credit chains and bankruptcy propagation in production networks," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2061-2084, June.
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    Cited by:

    1. Zunino, Luciano & Bariviera, Aurelio F. & Guercio, M. Belén & Martinez, Lisana B. & Rosso, Osvaldo A., 2016. "Monitoring the informational efficiency of European corporate bond markets with dynamical permutation min-entropy," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 456(C), pages 1-9.
    2. Jean-Philippe Bouchaud, 2012. "Crises and collective socio-economic phenomena: simple models and challenges," Papers 1209.0453,, revised Dec 2012.
    3. Batiz-Zuk, Enrique & López-Gallo, Fabrizio & Martínez-Jaramillo, Serafín & Solórzano-Margain, Juan Pablo, 2016. "Calibrating limits for large interbank exposures from a system-wide perspective," Journal of Financial Stability, Elsevier, vol. 27(C), pages 198-216.
    4. D. Sornette, 2014. "Physics and Financial Economics (1776-2014): Puzzles, Ising and Agent-Based models," Papers 1404.0243,

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