Financial crises and the evaporation of trust

Kartik Anand; Prasanna Gai; Matteo Marsili

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arXiv · 0911.3099

Financial crises and the evaporation of trust

Kartik Anand·Prasanna Gai·Matteo Marsili

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Abstract

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.

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Kartik Anand, Prasanna Gai, Matteo Marsili. 2009-11-16. Financial crises and the evaporation of trust. https://arxiv.org/abs/0911.3099

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