Domenico Delli Gatti

Bio: Domenico Delli Gatti is an academic researcher from Catholic University of the Sacred Heart. The author has contributed to research in topics: Financial fragility & Stylized fact. The author has an hindex of 29, co-authored 110 publications receiving 4460 citations. Previous affiliations of Domenico Delli Gatti include The Catholic University of America & University of Milan.

Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk

Abstract: We characterize the evolution over time of a network of credit relations among financial agents as a system of coupled stochastic processes. Each process describes the dynamics of individual financial robustness, while the coupling results from a network of liabilities among agents. The average level of risk diversification of the agents coincides with the density of links in the network. In addition to a process of diffusion of financial distress, we also consider a discrete process of default cascade, due to the re-evaluation of agents' assets. In this framework we investigate the probability of individual defaults as well as the probability of systemic default as a function of the network density. While it is usually thought that diversification of risk always leads to a more stable financial system, in our model a tension emerges between individual risk and systemic risk. As the number of counterparties in the credit network increases beyond a certain value, the default probability, both individual and systemic, starts to increase. This tension originates from the fact that agents are subject to a financial accelerator mechanism. In other words, individual financial fragility feeding back on itself may amplify the effect of an initial shock and lead to a full fledged systemic crisis. The results offer a simple possible explanation for the endogenous emergence of systemic risk in a credit network.

A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility

Abstract: In this paper, we discuss a scaling approach to business fluctuations. Our starting point consists in recognizing that concepts and methods derived from physics have allowed economists to (re)discover a set of stylized facts which have to be satisfactorily accounted for in their models. Standard macroeconomics, based on a reductionist approach centered on the representative agent, is definitely badly equipped for this task. On the contrary, we show that a simple financial fragility agent-based model, based on complex interactions of heterogeneous agents, is able to replicate a large number of scaling type stylized facts with a remarkable high degree of statistical precision.

Thinking fast and slow.

Abstract: In 1974 an article appeared in Science magazine with the dry-sounding title “Judgment Under Uncertainty: Heuristics and Biases” by a pair of psychologists who were not well known outside their discipline of decision theory. In it Amos Tversky and Daniel Kahneman introduced the world to Prospect Theory, which mapped out how humans actually behave when faced with decisions about gains and losses, in contrast to how economists assumed that people behave. Prospect Theory turned Economics on its head by demonstrating through a series of ingenious experiments that people are much more concerned with losses than they are with gains, and that framing a choice from one perspective or the other will result in decisions that are exactly the opposite of each other, even if the outcomes are monetarily the same. Prospect Theory led cognitive psychology in a new direction that began to uncover other human biases in thinking that are probably not learned but are part of our brain’s wiring.

Deciphering the Liquidity and Credit Crunch 2007-08

Abstract: This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.

Deciphering the Liquidity and Credit Crunch 2007-2008

Abstract: The financial market turmoil in 2007 and 2008 has led to the most severe financial crisis since the Great Depression and threatens to have large repercussions on the real economy The bursting of the housing bubble forced banks to write down several hundred billion dollars in bad loans caused by mortgage delinquencies At the same time, the stock market capitalization of the major banks declined by more than twice as much While the overall mortgage losses are large on an absolute scale, they are still relatively modest compared to the $8 trillion of US stock market wealth lost between October 2007, when the stock market reached an all-time high, and October 2008 This paper attempts to explain the economic mechanisms that caused losses in the mortgage market to amplify into such large dislocations and turmoil in the financial markets, and describes common economic threads that explain the plethora of market declines, liquidity dry-ups, defaults, and bailouts that occurred after the crisis broke in summer 2007 To understand these threads, it is useful to recall some key factors leading up to the housing bubble The US economy was experiencing a low interest rate environment, both because of large capital inflows from abroad, especially from Asian countries, and because the Federal Reserve had adopted a lax interest rate policy Asian countries bought US securities both to peg the exchange rates at an export-friendly level and to hedge against a depreciation of their own currencies against the dollar, a lesson learned from the Southeast Asian crisis of the late 1990s The Federal Reserve Bank feared a deflationary period after the bursting of the Internet bubble and thus did not counteract the buildup of the housing bubble At the same time, the banking system underwent an important transformation The