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Network Formation and Systemic Risk, Second Version

Author

Listed:
  • Selman Erol

    (Department of Economics, University of Pennsylvania)

  • Rakesh Vohra

    (Department of Economics, and Department of Electrical & Systems Engineering, University of Pennsylvania)

Abstract

This paper introduces a model of endogenous network formation and systemic risk. In it, strategic agents form networks that efficiently trade-off the possibility of systemic risk with the benefits of trade. Efficiency is a consequence of the high risk of contagion which forces agents to endogenize their externalities. Second, fundamentally ‘safer’ economies generate much higher interconnectedness, which in turn leads to higher systemic risk. Third, the structure of the network formed depends crucially on whether the shocks to the system are believed to be correlated or independent of each other. This underlines the importance of specifying the shock structure before investigating a given network as a particular network and shock structure could be incompatible.

Suggested Citation

  • Selman Erol & Rakesh Vohra, 2014. "Network Formation and Systemic Risk, Second Version," PIER Working Paper Archive 15-001, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 19 Dec 2014.
    • Handle: RePEc:pen:papers:15-001
    as

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    References listed on IDEAS

    as
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    5. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-638, August.
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    8. Adam Zawadowski, 2013. "Entangled Financial Systems," The Review of Financial Studies, Society for Financial Studies, vol. 26(5), pages 1291-1323.
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    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Spiros Bougheas, 2017. "Contagion in Stable Networks," Working Papers 2017.50, Fondazione Eni Enrico Mattei.
    2. Elliott, Matthew & Georg, Co-Pierre & Hazell, Jonathon, 2021. "Systemic risk shifting in financial networks," Journal of Economic Theory, Elsevier, vol. 191(C).
    3. Bougheas, Spiros, 2022. "Contagion in networks: Stability and efficiency," Mathematical Social Sciences, Elsevier, vol. 115(C), pages 64-77.
    4. Zafer Kanık, 2017. "Rescuing the Financial System: Capabilities, Incentives, and Optimal Interbank Networks," Working Papers 17-17, NET Institute.
    5. Elliott, M. & Georg, C-P. & Hazell, J., 2020. "Systemic Risk-Shifting in Financial Networks," Cambridge Working Papers in Economics 2068, Faculty of Economics, University of Cambridge.
    6. Barroso, Ricardo Vieira & Lima, Joaquim Ignacio Alves Vasconcellos & Lucchetti, Alexandre Henrique & Cajueiro, Daniel Oliveira, 2016. "Interbank network and regulation policies: an analysis through agent-based simulations with adaptive learning," MPRA Paper 73308, University Library of Munich, Germany.

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    More about this item

    Keywords

    Network Formation; Systemic Risk; Contagion; Rationalizability; Core;
    All these keywords.

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G01 - Financial Economics - - General - - - Financial Crises

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