Home

>

Contagious Synchronization and Endogenous Network Formation in Financial Networks

8 August 2014
Publication Type: Working Paper
JEL Code: C73, D53, D85, G21

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.

Series title: Working paper 450
1 August 2014
SHARE THIS Working Paper PUBLICATION:
Share on facebook
Share on twitter
Share on linkedin
Share on telegram
Share on whatsapp
Share on email