Sunday, September 13, 2009

The Integration of Social Networks and Financial Networks: Read the Book and Our Papers

The New York Times has an article, Wall Street’s Math Wizards Forgot a Few Variables, which emphasizes that variables "were missed" in some of the financial models and this, in turn, helped to precipitate the financial crisis.

In particular, the article quotes Professor Figlewski of Cornell and Professor Andrew Lo of MIT, both of whom differ in how the financial models should have been extended and made more realistic, but do concur that important variables were missing in the math financial models.

The article also emphasizes that trust and relationships should have been incorporated and factored into the models since many financial problems/issues rely on social networks. In addition, more general representations of risk should have been incorporated.

Actually, in a series of publications, we did include additional variables, and quite general risk measures, and we demonstrated how social and financial networks can be modeled in an integrated manner! In social networks, the flows are relationships, whereas in financial networks, the flows are financial transactions.

In 2007, we (Dr. Anna Nagurney, Dr. Jose M. Cruz of the School of Business at UCONN, and Dr. Tina Wakolbinger, now at the Fogelman College of Business and Economics at the University of Memphis) wrote the invited chapter, The Co-Evolution and Emergence of Integrated International Financial Networks and Social Networks: Theory, Analysis, and Computations, which appeared in the book, Globalization and Regional Economic Modelling, edited by B. Cooper, K. Donaghy (now at Cornell), and G. Hewings. This paper extended the results in our paper, The Evolution and Emergence of Integrated Social and Financial Networks with Electronic Transactions: A Supernetwork Theory for the Modeling, Analysis, and Computation of Financial Flows and Relationship Levels, published in 2006 in the journal Computational Economics, to the international domain. Another related paper of ours is, Financial Engineering of the Integration of Global Supply Chain Networks and Social Networks with Risk Management, which appeared in the journal Naval Research Logistics in 2006.

In fact, Dr. Wakolbinger's 2007 doctoral dissertation was entitled, A Dynamic Theory for the Integration of Social and Economic Networks with Application to Supply Chain and Financial Networks. For the abstract and other relevant dissertation information, click here.

The NYTimes article also notes that an econophysics approach is being used at the Santa Fe Institute to study complex networks and contagion. Already in 2003, Dr. Ke and I published a paper on financial networks in Quantitative Finance, which is a journal published by the Institute of Physics.

Another aspect of the critical importance and relevance of our integrated social and financial network models is that one can then assess, in the case of disruptions, the effects of the failure of particular nodes (think: banks, households, etc.) as well as links, be they electronic or physical.

Our Fragile Networks book, see image above, reveals how one can also measure financial network efficiency as well as financial system vulnerability.

As for the degree of separation, we are delighted that Professor Andrew Lo will be speaking in our Speaker Series at the Isenberg School of Management on October 2, 2009. We will also be hosting Professor Sam Bowles of the Santa Fe Institute in November.