Let’s be honest — we can’t really explain most of this (HT @pkedrosky), emphasis ours:
We model the spreading of a crisis by constructing a global economic network and applying the Susceptible-Infected-Recovered (SIR) epidemic model with a variable probability of infection. The probability of infection depends on the strength of economic relations between the pair of countries, and the strength of the target country. It is expected that a crisis which originates in a large country, such as the USA, has the potential to spread globally, like the recent crisis. Surprisingly we show that also countries with much lower GDP, such as Belgium, are able to initiate a global crisis. Using the k-shell decomposition method to quantify the spreading power (of a node), we obtain a measure of “centrality” as a spreader of each country in the economic network. We thus rank the different countries according to the shell they belong to, and find the 12 most central countries. These countries are the most likely to spread a crisis globally. Of these 12 only six are large economies, while the other six are medium/small ones, a result that could not have been otherwise anticipated. Furthermore, we use our model to predict the crisis spreading potential of countries belonging to different shells according to the crisis magnitude.
The lucky twelve: China, Russia, Japan, Spain, United Kingdom, Netherlands, Italy, Germany, Belgium (!), Luxembourg (!!), USA, and France.
This paper has all the hallmarks of physics envy in finance, except that two of the four authors work in actual physics departments (the other two are a geoscientist and an economist).
But now we’re being rude. The authors say they’ve modeled the potential for each country to spread a crisis throughout the world by taking into account its largest companies (including foreign subsidiaries), foreign investment, and international trading network.
They add that their model, as applied to a crisis started in the US, predicted roughly the same “infected” countries as those that were hit in the recent actual crisis.
Alright then. Since we’re not remotely qualified to evaluate something like this, and this is a purely speculative model, we’ll just post this chart — which allegedly explains something — and be on our way:
Caveat reader. And people who do business with Luxembourg.
Related links:
Worldwide spreading of economic crisis – arXiv.org
It’s not the length of the equations, but what you do with them – FT Alphaville