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Cascades in Networks and Aggregate Volatility

  • Daron Acemoglu
  • Asuman Ozdaglar
  • Alireza Tahbaz-Salehi

We provide a general framework for the study of cascade effects created by interconnections between sectors, firms or financial institutions. Focusing on a multi sector economy linked through a supply network, we show how structural properties of the supply network determine both whether aggregate volatility disappears as the number of sectors increases (i.e., whether the law of large numbers holds) and when it does, the rate at which this happens. Our main results characterize the relationship between first order interconnections (captured by the weighted degree sequence in the graph induced by the input-output relations) and aggregate volatility, and more importantly, the relationship between higher-order interconnections and aggregate volatility. These higher-order interconnections capture the cascade effects, whereby low productivity or the failure of a set of suppliers propagates through the rest of the economy as their downstream sectors/firms also suffer and transmit the negative shock to their downstream sectors/firms. We also link the probabilities of tail events (large negative deviations of aggregate output from its mean) to sector-specific volatility and to the structural properties of the supply network.

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File URL: http://www.nber.org/papers/w16516.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16516.

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Date of creation: Nov 2010
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Publication status: published as (With Vasco Carvalho, Asuman Ozdaglar, Alireza Tahbaz - Salehi ) Network Origins of Aggregate Fluctuat ions, September 2012, Econometrica , 80(5), pp.1977 - 2016.
Handle: RePEc:nbr:nberwo:16516
Note: IO
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  1. Vasco M Carvalho, 2008. "Aggregate Fluctuations and the Network Structure of Intersectoral Trade," 2008 Meeting Papers 1062, Society for Economic Dynamics.
  2. Markus K. Brunnermeier & Gary Gorton & Arvind Krishnamurthy, 2012. "Risk Topography," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 149 - 176.
    • Markus K. Brunnermeier & Gary Gorton & Arvind Krishnamurthy, 2011. "Risk Topography," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 149-176 National Bureau of Economic Research, Inc.
  3. Dupor, Bill, 1999. "Aggregation and irrelevance in multi-sector models," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 391-409, April.
  4. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," Economics Working Papers ECO2010/26, European University Institute.
  5. Xavier Gabaix, 2005. "The Granular Origins of Aggregate Fluctuations," 2005 Meeting Papers 470, Society for Economic Dynamics.
  6. Xavier Gabaix & Rustam Ibragimov, 2011. "Rank - 1 / 2: A Simple Way to Improve the OLS Estimation of Tail Exponents," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 29(1), pages 24-39, January.
  7. Timothy G. Conley & Bill Dupor, 2003. "A Spatial Analysis of Sectoral Complementarity," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 311-352, April.
  8. Xavier Gabaix, 2009. "Power Laws in Economics and Finance," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 255-294, 05.
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