A Network Theory of Financial Cascades

33 Pages Posted: 29 Jul 2008

See all articles by Michael Naylor

Michael Naylor

Massey University - School of Economics and Finance

Lawrence C. Rose

Massey University

Brendan J. Moyle

Massey University - Department of Commerce

Date Written: July 29, 2008

Abstract

International financial markets instability, as exhibited by persistent periodic crises, is a concern for all market participants. This paper presents an alternative theory of financial crises using recent developments in network theory. Simulation is used to apply the theory to short-term currency crises. The simulated model, despite being parsimonious, is capable of generating non-Gaussian complex outcomes, including cascades. Crisis dynamics are shown to be predominately generated by the pattern of inter-agent linkages and agent characteristics.

We conclude use of agent-based complex network models will improve understanding of the dynamics of market crises and should form part of financial dynamic analysis. While periodic crises may be inevitable, we argue market participants may be able to use knowledge of topology to reduce losses from future crises.

Keywords: Information cascades, foreign exchange dynamics, complex networks, heterogeneous agents, simulation, financial risk

JEL Classification: C15, F31, G12

Suggested Citation

Naylor, Michael and Rose, Lawrence (Larry) Craig and Moyle, Brendan J., A Network Theory of Financial Cascades (July 29, 2008). Available at SSRN: https://ssrn.com/abstract=1184604 or http://dx.doi.org/10.2139/ssrn.1184604

Michael Naylor (Contact Author)

Massey University - School of Economics and Finance ( email )

Private Bag 11-222
Palmerston North, 30974
New Zealand

Lawrence (Larry) Craig Rose

Massey University ( email )

Private Bag 102-904
North Shore Mail Centre
Auckland, 0745
New Zealand
+64 9 4140800, ex 9558 (Phone)
+64 9 441 8150 (Fax)

Brendan J. Moyle

Massey University - Department of Commerce ( email )

Auckland
New Zealand

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