Financial Crisis Model More Complex Than Information Cascades
The Financial Crisis of 2008 was one of the largest economic occurrences in history. During the Recession and for years after, scientists have closely studied and theorized the reasons behind the cause of this particular financial crisis, and of general crashing of financial markets everywhere. A very popular model that has been widely accepted based the reasoning behind the idea of information cascades. However, this is a very simple model, and financial markets in reality are much more complex with overlapping layers within the networks, specifically with respect to debt structures. If a financial institution were to go bankrupt, “creditors with high-priority bonds (called senior bonds) can be fully repaid from the institution’s remaining assets, while lower-priority creditors (those with junior bonds) cannot.”
Dr. Kobayashi and his team at Kobe University has recently constructed a new model that explains this financial crisis by accounting for the complexities of the differences in the priority of debt repayments. Using a multi-layer approach, senior bonds and junior bonds were put on separate layers to account for the priority difference of debt non-repayment risk. This revolutionary research can potentially change global financial regulation to better project and account for future financial crises.
As we learned in class, information cascades are decisions made by people that are based on their observations of other people’s decisions, despite their own personal opinions and preferences. It is a very large phenomenon that is seen in many areas of real-life events and practices. However, this is an example about how there are some occurrences that are too complex to be explained by the simple information cascade model, but rather by a much more advanced network model. These concepts are probably taught more in depth in a more advanced networks or economic course.
Sources: http://journals.aps.org/pre/abstract/10.1103/PhysRevE.91.062813
http://www.asianscientist.com/2015/08/in-the-lab/kobe-physics-financial-crisis/
http://phys.org/news/2015-07-mechanism-financial-crisis.html