Sean Carr

Financial innovation and the consequences of complexity: insights from major US banking crises

Complexity and instability have been persistent features of the American financial system since the earliest days of the republic. Beginning with Alexander Hamilton’s Bank of the United States in 1791, the growth of the banking sector and the everdeepening interconnections among banks and banklike institutions have coincided with cycles of crashes, panics, financial crises, and, in some cases, depressions. One view is that the absolute complexity1 of the financial system, especially in its instruments and institutions, is itself a material source of the instability; that is, as the banking sector has grown more complex, so has its tendency toward disequilibrium and dysfunction. We suggest an alternate view that complexity by itself is not a sufficient condition to precipitate systemic vulnerability. Instead, we observe that complex financial systems may fall out of equilibrium with the introduction (or adoption) of novel financial instruments, institutions or markets – that is, financial innovations. Such innovations have the potential, we suggest, to amplify negative dynamics within complex systems and, under certain conditions, may result in significant adverse consequences. Drawing from the growing body of literature that applies concepts from the study of complex adaptive systems to economics (for example, Arthur, 2014) and financial markets (for example, Beinhocker, 2007; Sornette, 2003), this chapter explores two interrelated features of complex financial systems that may serve as the mechanisms by which innovation can induce financial instability: tight linkages and information flows. The systemlike architecture of the banking sector often creates opacity that makes it difficult for information to flow freely when trouble occurs; also, a complex system creates tight linkages whereby the trouble itself can quickly spread.

Antecedents of Entrepreneurial Decision-Making: Prediction and Control Oriented Strategies

The economics-related prediction strategies and the effectuation-related control strategies are two main competing hypotheses of how entrepreneurs deal with uncertainty in theories of entrepreneurship. In an experimental test, we study the conditions under which prediction and control strategies lead subjects to make a risky bet in ambiguous environments. Individuals who use predictive methods to gain information and mitigate risks are more likely to accept the bet after receiving bad news as compared to those who used control methods. These results revert in the presence of good news. We discuss the theoretical implications of the results for theories of entrepreneurship.