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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: G21 C73 D53 D85 (search for similar items in EconPapers)
Date: 2015
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Related works:
Working Paper: Contagious Synchronization and Endogenous Network Formation in Financial Networks (2014) Downloads
Working Paper: Contagious Synchronization and Endogenous Network Formation in Financial Networks (2014) Downloads
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