Architectures engender crises: The emergence of power laws in social networks

Abstract

Recent financial crises posed a number of questions. The most salient were related to the cogency of derivatives and other sophisticated hedging instruments. One claim is that all those instruments rely heavily on the assumption that events in the world are guided by normal distributions while, instead, all the evidence shows that they actually follow fat-tailed power laws. Our conjecture is that it is the very financial architecture that engenders extreme events. Not on purpose but just because of its complexity. That is, the system has an internal connection structure that is able to propagate and enhance initially small disturbances. The final outcome ends up not being correlated with its triggering event. To support this claim, we appeal to the intuition drawn from the behavior of social networks. Most of the interesting cases constitute scale-free structures. In particular, we contend, those that arise from strategic decisions of the agents.