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Risk-Sharing and Contagion in Networks

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  • Antonio Cabrales
  • Piero Gottardi
  • Fernando Vega-Redondo

Abstract

We investigate the trade-off between the risk-sharing gains enjoyed by more interconnected firms and the costs resulting from an increased risk exposure. We find that when the shock distribution displays “fat” tails, extreme segmentation into small components is optimal, while minimal segmentation and high density of connections are optimal when the distribution exhibits “thin” tails. For less regular distributions, intermediate degrees of segmentation and sparser connections are optimal. Also, if firms are heterogeneous, optimality requires perfect assortativity in a component. In general, however, a conflict arises between efficiency and pairwise stability, due to a “size externality” not internalized by firms.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4715.

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Date of creation: 2014
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Handle: RePEc:ces:ceswps:_4715

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Keywords: firm networks; contagion; risk sharing;

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  1. Xavier Freixas & Bruno M. Parigi & Jean-Charles Rochet, 2000. "Systemic risk, interbank relations, and liquidity provision by the central bank," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 611-640.
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  7. FrancisX. Diebold & Kamil Yilmaz, 2009. "Measuring Financial Asset Return and Volatility Spillovers, with Application to Global Equity Markets," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 119(534), pages 158-171, 01.
  8. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, American Finance Association, vol. 60(6), pages 2925-2953, December.
  9. Bloch, Francis & Genicot, Garance & Ray, Debraj, 2008. "Informal insurance in social networks," Journal of Economic Theory, Elsevier, Elsevier, vol. 143(1), pages 36-58, November.
  10. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(6), pages 2033-2060, June.
  11. Goyal, Sanjeev & Vega-Redondo, Fernando, 2007. "Structural holes in social networks," Journal of Economic Theory, Elsevier, Elsevier, vol. 137(1), pages 460-492, November.
  12. Yann Bramoullé & Rachel Kranon, 2005. "Risk-Sharing Networks," Cahiers de recherche, CIRPEE 0526, CIRPEE.
  13. Antoni Calvó-Armengol & Rahmi İlkılıç, 2009. "Pairwise-stability and Nash equilibria in network formation," International Journal of Game Theory, Springer, Springer, vol. 38(1), pages 51-79, March.
  14. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2013. "Systemic Risk and Stability in Financial Networks," NBER Working Papers 18727, National Bureau of Economic Research, Inc.
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