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Pathways towards instability in financial networks

Author

Listed:
  • Bardoscia, Marco
  • Battiston, Stefano
  • Caccioli, Fabio
  • Caldarelli, Guido

Abstract

Following the financial crisis of 2007–2008, a deep analogy between the origins of instability in financial systems and complex ecosystems has been pointed out: in both cases, topological features of network structures influence how easily distress can spread within the system. However, in financial network models, the details of how financial institutions interact typically play a decisive role, and a general understanding of precisely how network topology creates instability remains lacking. Here we show how processes that are widely believed to stabilize the financial system, that is, market integration and diversification, can actually drive it towards instability, as they contribute to create cyclical structures which tend to amplify financial distress, thereby undermining systemic stability and making large crises more likely. This result holds irrespective of the details of how institutions interact, showing that policy-relevant analysis of the factors affecting financial stability can be carried out while abstracting away from such details.

Suggested Citation

  • Bardoscia, Marco & Battiston, Stefano & Caccioli, Fabio & Caldarelli, Guido, 2017. "Pathways towards instability in financial networks," LSE Research Online Documents on Economics 69904, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:69904
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    Keywords

    applied mathematics; complex networks; economics;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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