Contagious synchronization and endogenous network formation in financial networks

Christoph Aymanns and Co-Pierre Georg ()

Journal of Banking & Finance, 2015, vol. 50, issue C, 273-285

Abstract: When banks choose similar investment strategies the financial system becomes vulnerable to common shocks. We model a simple financial system in which banks decide about their investment strategy based on a private belief about the state of the world and a social belief formed from observing the actions of peers. Observing a larger group of peers conveys more information and thus leads to a stronger social belief. Extending the standard model of Bayesian updating in social networks, we show that the probability that banks synchronize their investment strategy on a state non-matching action critically depends on the weighting between private and social belief. This effect is alleviated when banks choose their peers endogenously in a network formation process, internalizing the externalities arising from social learning.

Keywords: Social learning; Endogenous financial networks; Multi-agent simulations; Systemic risk (search for similar items in EconPapers)
JEL-codes: C73 D53 D85 G21 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Related works:
Working Paper: Contagious Synchronization and Endogenous Network Formation in Financial Networks (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:50:y:2015:i:c:p:273-285

DOI: 10.1016/j.jbankfin.2014.06.030

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