May, Levin & Sugihara: Ecology for bankers | Nature
One year after the Wall Street meltdown, I was looking back at an article from February 2008, "Complex systems: Ecology for bankers," by Robert May, Simon Levin and George Sugihara.
[T]o what extent can study of ecosystems inform the design of financial networks in, for instance, their robustness against perturbation? ... An example of this kind emerges from work on the network structure of communities of pollinators and the plants they pollinate. These networks are disassortative, in the sense that highly connected 'large' nodes tend to have their connections disproportionately with 'small' nodes; conversely, small nodes connect with disproportionately few large ones. The authors3 show that such disassortative networks tend to confer a significant degree of stability against disturbance. More generally, ecologists and others have long suggested that modularity — the degree to which the nodes of a system can be decoupled into relatively discrete components — can promote robustness. ...
[M]odularity will often involve a trade-off between local and systemic risk. Moreover, the wrong compartmentalization in financial markets could preclude stabilizing feedbacks, such as mechanisms for maintaining liquidity of cash flows through the financial system, where fragmentation leading to illiquidity could actually increase systemic risk (as in the bank runs leading to the Great Depression). Redundancy of components and pathways, in which one can substitute for another, is also a key element in the robustness of complex systems, and effective redundancy is not independent of modularity. ...
[A]lthough the study of payment flows is of immediate interest to central bankers, it may miss an essential aspect of systemic risk, namely the 'contagion dynamics' of public perceptions and asset valuation associated with the interaction of balance-sheets (the mutual financial obligations and exposures that link companies). For example, how contagious are inflated valuations of Internet stocks? Are there hidden, mutually dependent risks associated with such high valuations? It could be useful to examine the dynamic network of balance-sheets, and if possible to quantify the inter active effects of valuations, credit policies, hedging and so on among financial institutions, especially investment banks.
By the way, Simon Levin is editor of the new Princeton Guide to Ecology.
