Epidemics of Rules, Information Aggregation Failure and Market Crashes

13 Pages Posted: 15 Jun 2010

See all articles by Matteo Marsili

Matteo Marsili

Abdus Salam International Centre for Theoretical Physics (ICTP)

Alan Kirman

GREQAM

Kartik Anand

Technische Universität Berlin (TU Berlin)

Date Written: March 15, 2010

Abstract

This short paper argues that rationally motivated coordination between agents is an important ingredient to understand the current economic crisis. We argue that changes in parameters that model the structure of a macro-economy or financial markets are not exogenous but arise as agents adopt rules that appear to be the norm around them. For example, if a rule is adopted by the majority of ones' neighbors it will become acceptable or, alternatively, if agents learn that changing their rule leads to greater gains, they will modified their rules. However, as rules develop and spread they may have consequences at the aggregate level which are not anticipated by individuals. These rules may be adopted by implicit consensus as they turn out to be profitable for individuals, but they may also weaken the constraints imposed by regulators. Indeed, the emergence of new rules or the modification of old ones may render the whole system more fragile, which may then cease to function. To illustrate this we develop a simple model, motivated by the 2007-2008 crisis in credit derivatives markets, to show how coordination on simple and apparently profitable rules may cause a market to collapse.

Keywords: Coordination games, Asset price bubbles, Financial Crises

JEL Classification: D83, C71, G01, G24

Suggested Citation

Marsili, Matteo and Kirman, Alan and Anand, Kartik, Epidemics of Rules, Information Aggregation Failure and Market Crashes (March 15, 2010). Available at SSRN: https://ssrn.com/abstract=1624803 or http://dx.doi.org/10.2139/ssrn.1624803

Matteo Marsili (Contact Author)

Abdus Salam International Centre for Theoretical Physics (ICTP) ( email )

Strada Costiera 11
Trieste, 34014
Italy

Alan Kirman

GREQAM ( email )

Centre de la Vieille Charité
2, rue de la Charité
Marseille, 13002
France
+3391140770 (Phone)
+3391900227 (Fax)

Kartik Anand

Technische Universität Berlin (TU Berlin) ( email )

Straße des 17
Juni 135
Berlin, 10623
Germany

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