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Contagious Synchronization and Endogenous Network Formation in Financial Networks

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  • Christoph Aymanns
  • Co-Pierre Georg
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.

Suggested Citation

  • Christoph Aymanns & Co-Pierre Georg, 2014. "Contagious Synchronization and Endogenous Network Formation in Financial Networks," Papers 1408.0440, arXiv.org.
    • Handle: RePEc:arx:papers:1408.0440
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    Cited by:

    1. Naji Massad & Jørgen Vitting Andersen, 2017. "Three different ways synchronization can cause contagion in financial markets," Post-Print halshs-01673333, HAL.
    2. Wolski, Marcin & van de Leur, Michiel, 2016. "Interbank loans, collateral and modern monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 388-416.
    3. Roy Cerqueti & Francesca Pampurini & Annagiulia Pezzola & Anna Grazia Quaranta, 2022. "Dangerous liasons and hot customers for banks," Review of Quantitative Finance and Accounting, Springer, vol. 59(1), pages 65-89, July.
    4. Naji Massad & Jørgen Vitting Andersen, 2018. "Three Different Ways Synchronization Can Cause Contagion in Financial Markets," Risks, MDPI, vol. 6(4), pages 1-13, September.
    5. Naji Massad & Jørgen Vitting Andersen, 2017. "Three different ways synchronization can cause contagion in financial markets," Documents de travail du Centre d'Economie de la Sorbonne 17059, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    6. Naji Massad & Jørgen Vitting Andersen, 2018. "Three Different Ways Synchronization Can Cause Contagion in Financial Markets," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01951164, HAL.
    7. Hałaj, Grzegorz & Peltonen, Tuomas A. & Scheicher, Martin, 2018. "How did the Greek credit event impact the credit default swap market?," Journal of Financial Stability, Elsevier, vol. 35(C), pages 136-158.
    8. Carlos León, 2020. "Banks in Colombia: How Homogeneous Are They?," Revista de Economía del Rosario, Universidad del Rosario, vol. 23(2), pages 1-32, December.
    9. Naji Massad & Jørgen Vitting Andersen, 2018. "Three Different Ways Synchronization Can Cause Contagion in Financial Markets," Post-Print hal-01951164, HAL.
    10. Naji Massad & J{o}rgen Vitting Andersen, 2019. "Three Different Ways Synchronization Can Cause Contagion in Financial Markets," Papers 1902.10800, arXiv.org.
    11. Hüser, Anne-Caroline, 2016. "Too interconnected to fail: A survey of the Interbank Networks literature," SAFE Working Paper Series 91, Leibniz Institute for Financial Research SAFE, revised 2016.
    12. Naji Massad & Jørgen Vitting Andersen, 2017. "Three different ways synchronization can cause contagion in financial markets," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-01673333, HAL.
    13. Jiajia, Liu & Kun, Guo & Fangcheng, Tang & Yahan, Wang & Shouyang, Wang, 2023. "The effect of the disposal of non-performing loans on interbank liquidity risk in China: A cash flow network-based analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 89(C), pages 105-119.
    14. Shouwei Li & Shihang Wen, 2017. "Multiplex Networks of the Guarantee Market: Evidence from China," Complexity, Hindawi, vol. 2017, pages 1-7, July.
    15. De Caux, Robert & McGroarty, Frank & Brede, Markus, 2017. "The evolution of risk and bailout strategy in banking systems," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 468(C), pages 109-118.
    16. Li, Shouwei & Sui, Xin, 2016. "Contagion risk in endogenous financial networks," Chaos, Solitons & Fractals, Elsevier, vol. 91(C), pages 591-597.

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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation

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