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The Lehman Brothers Effect and Bankruptcy Cascades

Author

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

Suggested Citation

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

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    1. J. Lorenz & S. Battiston & F. Schweitzer, 2009. "Systemic risk in a unifying framework for cascading processes on networks," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 71(4), pages 441-460, October.
    2. 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.
    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.
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    9. 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.
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    11. Pawe{l} Sieczka & Janusz A. Ho{l}yst, 2009. "Collective firm bankruptcies and phase transition in rating dynamics," Papers 0904.4430, arXiv.org, revised Sep 2009.
    12. D. Sornette, 2000. "Stock Market Speculation: Spontaneous Symmetry Breaking of Economic Valuation," Papers cond-mat/0004001, arXiv.org.
    13. Kartik Anand & Reimer Kuhn, 2006. "Phase Transitions in Operational Risk," Papers physics/0609130, arXiv.org, revised Dec 2006.
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    Cited by:

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    2. Didier SORNETTE, 2014. "Physics and Financial Economics (1776-2014): Puzzles, Ising and Agent-Based Models," Swiss Finance Institute Research Paper Series 14-25, Swiss Finance Institute.
    3. 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.
    4. Didier Wernli & Lucas Böttcher & Flore Vanackere & Yuliya Kaspiarovich & Maria Masood & Nicolas Levrat, 2023. "Understanding and governing global systemic crises in the 21st century: A complexity perspective," Global Policy, London School of Economics and Political Science, vol. 14(2), pages 207-228, May.
    5. Fang, Libing & Sun, Boyang & Li, Huijing & Yu, Honghai, 2018. "Systemic risk network of Chinese financial institutions," Emerging Markets Review, Elsevier, vol. 35(C), pages 190-206.
    6. Andre R. Neveu, 2018. "A survey of network-based analysis and systemic risk measurement," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 13(2), pages 241-281, July.
    7. Hayato Goto & Hideki Takayasu & Misako Takayasu, 2017. "Estimating risk propagation between interacting firms on inter-firm complex network," PLOS ONE, Public Library of Science, vol. 12(10), pages 1-12, October.
    8. 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.
    9. Sorin ȘOMÎTCĂ & Alina CRÎȘMARIU (ȘOMÎTCĂ), 2022. "The Two Sides of the Coin – The Success and Failure of the Business," CECCAR Business Review, Body of Expert and Licensed Accountants of Romania (CECCAR), vol. 3(8), pages 56-62, August.
    10. Piotr Łasak & Sławomir Wyciślak, 2022. "Dynamics in Complex Systems Amidst Crisis 2008+: Financial Regulatory and Supervisory Reflections," Risks, MDPI, vol. 10(2), pages 1-15, February.
    11. Jean-Philippe Bouchaud, 2012. "Crises and collective socio-economic phenomena: simple models and challenges," Papers 1209.0453, arXiv.org, revised Dec 2012.

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