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Systemic Financial Risk

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This report analyses the results of simulations using an agent based model of financial markets to show how excessive levels of leverage in financial markets can lead to a systemic crash.  Investors overload on risky assets betting more than they have to gamble creating a tremendous level of vulnerability in the system as a whole.  Plummeting asset prices render banks unable or unwilling to provide credit as they fear they might be unable to cover their own liabilities due to potential loan defaults.  Whether an overleveraged borrower is a sovereign nation or major financial institution, recent history illustrates how defaults carry the risk of contagion in a globally interconnected economy. The resulting slowdown of investment in the real economy impacts actors at all levels, from small businesses to homebuyers. Bankruptcies lead to job losses and a drop in aggregate demand, leading to more businesses and individuals being unable to repay their loans, reinforcing a downward spiral that can trigger a recession, depression or bring about stagflation in the real economy. This can have a devastating impact not only on economic prosperity across the board, but also consumer sentiment and trust in the ability of the system to generate long-term wealth and growth.   

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Social unrest and agent based models

In the same way as financial markets are complex systems and show potential systemic large-scale effects, dynamics of social unrest do. As argued above, agent based models - provided they capture essential features - allow for an understanding of a series of fundamental issues of dynamics of social unrest. In particular these models may help to estimate the role of certain conditions that lead to the outbreak of phases of large-scale non-cooperative behaviour. One of these models, which was mentioned in the context of financial markets, is on the verge of becoming sophisticated enough to be of actual use.

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