Financial Crisis in the Framework of Non-zero Temperature Balance Theory

TL;DR

This paper models financial crises using a higher-order balance theory framework, revealing structural differences in stock networks during crises and identifying a critical temperature indicating phase transitions.

Contribution

It introduces a triplet interaction model based on balance theory to analyze higher-order correlations in financial networks during crises.

Findings

Ordered network structures form during crises.

Network resistance correlates with crisis strength.

Critical temperature indicates phase transition point.

Abstract

Financial crises are known as crashes that result in a sudden loss of value of financial assets in large part and they continue to occur from time to time surprisingly. In order to discover features of the financial network, the pairwise interaction of stocks has been considered in many research, but the existence of the strong correlation of stocks and their collective behavior in crisis made us address higher-order interactions. Hence, in this study, we investigate financial networks by triplet interaction in the framework of balance theory. Due to detecting the contribution of higher-order interactions in understanding the complex behavior of stocks we take the advantage of the orders parameters of the higher-order interactions. Looking at real data of financial market obtained from $S\&P500$ through the lens of balance theory for the quest of network structure in different periods of time near and far from crisis reveals the existence of a structural difference of the network that corresponds to different periods of time. Here, we address two well-known crises the Great regression (2008) and the Covid-19 recession (2020). Results show an ordered structure forms on-crisis in the financial network while stocks behave independently far from a crisis. The formation of the ordered structure of stocks in crisis makes the network resistant against disorder. The resistance of the ordered structure against applying a disorder (temperature) can measure the crisis strength and determine the temperature at which the network transits. There is a critical temperature, $T_{c}$, in the language of statistical mechanics and mean-field approach which above, the ordered structure destroys abruptly and a first-order phase transition occurs. The stronger the crisis, the higher the critical temperature.