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Financial Contagion in Network Economies and Asset Prices

Author

Listed:
  • Andrea Buraschi

    (Finance, Imperial College, London SW7 2AZ, United Kingdom)

  • Claudio Tebaldi

    (Department of Finance, Bocconi University, 20135 Milan, Italy)

Abstract

This paper studies intertemporal asset pricing in network economies when distress shocks can propagate through the network, similarly to epidemic outbreaks. Two classes of equilibria exist. In the first, idiosyncratic shocks are diversifiable and do not affect valuations; the consumption capital asset pricing model applies. In the second, idiosyncratic shocks generate nondiversifiable long-run cascades of shocks (financial pandemics) that introduce a new risk premium component unexplained by traditional systematic factors. We derive closed solutions for asset prices as a function of the network properties and discuss their properties. After a structural break (1984), we find evidence of a network risk premium that is statistically and economically significant.

Suggested Citation

  • Andrea Buraschi & Claudio Tebaldi, 2024. "Financial Contagion in Network Economies and Asset Prices," Management Science, INFORMS, vol. 70(1), pages 484-506, January.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:1:p:484-506
    DOI: 10.1287/mnsc.2023.4687
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