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Strategic default in financial networks

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  • Allouch, Nizar
  • Jalloul, Maya
  • Duncan, Alfred

Abstract

This paper investigates a model of default in financial networks where the decision by one agent on whether or not to default impacts the incentives of other agents to escape default. Agents' payoffs are determined by the clearing mechanism introduced in the seminal contribution of Eisenberg and Noe (2001). We first show the existence of a Nash equilibrium of this default game. Furthermore, we develop an algorithm to find all Nash equilibria and guide regulatory intervention that relies on the financial network structure. The algorithm provides a ranking for the set of Nash equilibria for specific financial network structures, which can serve as a measure of systemic risk. Finally, we show that introducing a central clearing counterparty achieves the efficient equilibrium at no additional cost.

Suggested Citation

  • Allouch, Nizar & Jalloul, Maya & Duncan, Alfred, 2023. "Strategic default in financial networks," Games and Economic Behavior, Elsevier, vol. 142(C), pages 941-954.
    • Handle: RePEc:eee:gamebe:v:142:y:2023:i:c:p:941-954
    DOI: 10.1016/j.geb.2023.10.001
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    More about this item

    Keywords

    Systemic risk; Default; Financial networks; Coordination games; Ear decomposition; Central clearing counterparty; Financial regulation;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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