Too dynamic to fail. Empirical support for an autocatalytic model of Minsky's financial instability hypothesis

TL;DR

This paper empirically supports an autocatalytic model of financial instability, showing how feedback loops and network contagion among firms contribute to crises, with data from Italian firms validating the model's predictions.

Contribution

It introduces an empirical validation of an autocatalytic, agent-based model of financial instability, linking interest rates, firm resilience, and contagion dynamics.

Findings

The model accurately predicts ponzi firm numbers from 2002-2009 data.

Contagion effects become significant only when ponzi density exceeds a critical threshold.

Dynamic substitution among firms limits contagion spread during crises.

Abstract

Solomon and Golo [1] have recently proposed an autocatalytic (self-reinforcing) feedback model which couples a macroscopic system parameter (the interest rate), a microscopic parameter that measures the distribution of the states of the individual agents (the number of firms in financial difficulty) and a peer-to-peer network effect (contagion across supply chain financing). In this model, each financial agent is characterized by its resilience to the interest rate. Above a certain rate the interest due on the firm's financial costs exceeds its earnings and the firm becomes susceptible to failure (ponzi). For the interest rate levels under a certain threshold level, the firm loans are smaller then its earnings and the firm becomes 'hedge.' In this paper, we fit the historical data (2002-2009) on interest rate data into our model, in order to predict the number of the ponzi firms. We compare the prediction with the data taken from a large panel of Italian firms over a period of 9 years. We then use trade credit linkages to discuss the connection between the ponzi density and the network percolation. We find that the 'top-down'-'bottom-up' positive feedback loop accounts for most of the Minsky crisis accelerator dynamics. The peer-to-peer ponzi companies contagion becomes significant only in the last stage of the crisis when the ponzi density is above a critical value. Moreover the ponzi contagion is limited only to the companies that were not dynamic enough to substitute their distressed clients with new ones. In this respect the data support a view in which the success of the economy depends on substituting the static 'supply-network' picture with an interacting dynamic agents one.