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The dynamics of financial stability in complex networks
1 Departamento de Física, Faculdade de Ciências da Universidade de Lisboa, 1649-003 Lisboa, Portugal
2 Closer Consultoria Lda, Avenida Engenheiro Duarte Pacheco, Torre 2, 14°-C, 1070-102 Lisboa, Portugal
3 Center for Theoretical and Computational Physics, University of Lisbon, Av. Prof. Gama Pinto 2, 1649-003 Lisbon, Portugal
Received: 2 December 2011
Received in final form: 4 April 2012
Published online: 30 July 2012
We address the problem of banking system resilience by applying off-equilibrium statistical physics to a system of particles, representing the economic agents, modelled according to the theoretical foundation of the current banking regulation, the so called Merton-Vasicek model. Economic agents are attracted to each other to exchange ‘economic energy’, forming a network of trades. When the capital level of one economic agent drops below a minimum, the economic agent becomes insolvent. The insolvency of one single economic agent affects the economic energy of all its neighbours which thus become susceptible to insolvency, being able to trigger a chain of insolvencies (avalanche). We show that the distribution of avalanche sizes follows a power-law whose exponent depends on the minimum capital level. Furthermore, we present evidence that under an increase in the minimum capital level, large crashes will be avoided only if one assumes that agents will accept a drop in business levels, while keeping their trading attitudes and policies unchanged. The alternative assumption, that agents will try to restore their business levels, may lead to the unexpected consequence that large crises occur with higher probability.
Key words: Statistical and Nonlinear Physics
© EDP Sciences, Società Italiana di Fisica and Springer-Verlag, 2012