Contagious Herding and Endogenous Network Formation in Financial Networks

52 Pages Posted: 29 Jul 2014

See all articles by Co-Pierre Georg

Co-Pierre Georg

University of Cape Town; Deutsche Bundesbank

Date Written: July 9, 2014

Abstract

When banks choose similar investment strategies, the financial system becomes vulnerable to common shocks. Banks decide about their investment strategy ex-ante based on a private belief about the state of the world and a social belief formed from observing the actions of peers. When the social belief is strong and the financial network is fragmented, banks follow their peers and their investment strategies synchronize. This effect is stronger for less informative private signals. For endogenously formed interbank networks, however, less informative signals lead to higher network density and less synchronization. It is shown that the former effect dominates the latter.

Keywords: social learning, endogenous financial networks, multi-agent simulations, systemic risk

JEL Classification: G21, C73, D53, D85

Suggested Citation

Georg, Co-Pierre, Contagious Herding and Endogenous Network Formation in Financial Networks (July 9, 2014). ECB Working Paper No. 1700, Available at SSRN: https://ssrn.com/abstract=2464109

Co-Pierre Georg (Contact Author)

University of Cape Town ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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