The Self-Organized Criticality Paradigm in Economics & Finance

TL;DR

This paper reviews how Self-Organized Criticality (SOC) explains large fluctuations in economics and finance, suggesting that markets and economies naturally evolve to critical states where small shocks can cause large disruptions.

Contribution

It highlights the potential of SOC as a framework for understanding financial volatility and economic crises, emphasizing the importance of resilience over efficiency.

Findings

SOC explains fat-tailed fluctuations and long-memory correlations in markets.

Small shocks can trigger large disruptions due to avalanche effects.

Resilience policies are necessary alongside efficiency goals.

Abstract

``Self-Organised Criticality'' (SOC) is the mechanism by which complex systems spontaneously settle close to a *critical point*, at the edge between stability and chaos, and characterized by fat-tailed fluctuations and long-memory correlations. Such a scenario may explain why insignificant perturbations can generate large disruptions, through the propagation of ``avalanches'' across the system. In this short review, we discuss how SOC could offer a plausible solution to the excess volatility puzzle in financial markets and the analogue ``small shocks, large business cycle puzzle'' for the economy at large, as initially surmised by Per Bak et al. in 1993. We argue that in general the quest for efficiency and the necessity of *resilience* may be mutually incompatible and require specific policy considerations.