Dynamical modeling reveals systemic risk emergence in interconnected financial institutions, suggesting new insights into market stability.
Systemic financial risk refers to the simultaneous failure or destabilization of multiple financial institutions, often triggered by contagion mechanisms or common exposures to shocks. In this paper, we present a dynamical model of bank leverage-the ratio of asset holdings to equity-a quantity that both reflects and drives risk dynamics. We model how banks, constrained by Value-at-Risk regulations, adjust their leverage in response to changes in the price of a single asset, assumed to be held in a fixed proportion across banks. This leverage-targeting behavior introduces a procyclical feedback loop between asset prices and leverage. In the dynamics, this can manifest as logistic-like behavior with a rich bifurcation structure across model parameters. By analyzing these coupled dynamics in both isolated and interconnected bank models, we outline a framework for understanding how systemic risk can emerge from seemingly rational micro-level behavior.
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Ioffredi et al. (2026) studied this question.
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