Regensburg 2010 – scientific programme

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SOE: Fachverband Physik sozio-ökonomischer Systeme

SOE 23: Financial Markets and Risk Management III

SOE 23.2: Talk

Friday, March 26, 2010, 10:45–11:15, H44

Financial crises and the evaporation of trust — •Kartik Anand¹, Prasanna Gai², and Matteo Marsili¹ — ¹The Abdus Salam International Centre for Theoretical Physics, Trieste, Italy — ²The Australian National University, Crawford School of Economics and Government, Canberra, Australia

Trust lies at the crux of most economic transactions, with credit markets being a notable example. Drawing on insights from the literature on coordination games and network growth, we develop a simple model to clarify how trust breaks down in financial systems. We show how the arrival of bad news about a financial agent can lead others to lose confidence in it and how this, in turn, can spread across the entire system. Our results emphasize the role of hysteresis -- it takes considerable effort to regain trust once it has been broken. Although simple, the model provides a plausible account of the credit freeze that followed the global financial crisis of 2007/8, both in terms of the sequence of events and the measures taken (and being proposed) by the authorities.