Financial instability transition under heterogeneous investments and portfolio diversification
Abstract
We analyze the stability of financial investment networks, where financial institutions hold overlapping portfolios of assets. We consider the effect of portfolio diversification and heterogeneous investments using a random matrix dynamical model driven by portfolio rebalancing. While heterogeneity generally correlates with heightened volatility, increasing diversification may have a stabilizing or destabilizing effect depending on the connectivity level of the network. The stability/instability transition is dictated by the largest eigenvalue of the random matrix governing the time evolution of the endogenous components of the returns, for which different approximation schemes are proposed and tested against numerical diagonalization.
Keywords
Cite
@article{arxiv.2501.19260,
title = {Financial instability transition under heterogeneous investments and portfolio diversification},
author = {Preben Forer and Barak Budnick and Pierpaolo Vivo and Sabrina Aufiero and Silvia Bartolucci and Fabio Caccioli},
journal= {arXiv preprint arXiv:2501.19260},
year = {2025}
}
Comments
25 pages, 5 figures