Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
5088577 | Journal of Banking & Finance | 2015 | 13 Pages |
Abstract
When banks choose similar investment strategies the financial system becomes vulnerable to common shocks. We model a simple financial system in which banks decide about their investment strategy based on a private belief about the state of the world and a social belief formed from observing the actions of peers. Observing a larger group of peers conveys more information and thus leads to a stronger social belief. Extending the standard model of Bayesian updating in social networks, we show that the probability that banks synchronize their investment strategy on a state non-matching action critically depends on the weighting between private and social belief. This effect is alleviated when banks choose their peers endogenously in a network formation process, internalizing the externalities arising from social learning.
Related Topics
Social Sciences and Humanities
Economics, Econometrics and Finance
Economics and Econometrics
Authors
Christoph Aymanns, Co-Pierre Georg,