Trust is at the foundations of market economies, as starkly remarked by the recent financial crisis. Important progress has been made in understanding, from the game theoretic perspective, the mechanisms by which trust can break down, relating it to strategic uncertainty. The aim of this paper is to
scale these insights to the system level by analyzing a simple model of a large population of individuals engaged in credit relationships. This economy can converge to a “good” equilibrium, where a dense network of credit relations exists and the risk of a run, and subsequent default, is negligible. However, a “bad” equilibrium is also possible: Here the credit network is sparse because investors are more nervous and prone to prematurely foreclose their credit relationships, thereby precipitating counter-party default and contagion. The transition between the two equilibria is sharp and both states exhibit a degree of resilience; once a credit crisis tips the system into the sparse state state, the restoration of a dense credit network requires a shift of the parameters well beyond the turning point. At the same time, when the system reverts to the good state, this is robust even to deteriorating conditions.
Matteo Marsili, Abdus Salam International Centre for Theoretical Physics, Trieste, Italie