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Risk Sharing and Contagion in Networks

Author

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  • Piero Gottardi

    (European University Institute)

  • Fernando Vega-Redondo

    (Bocconi University)

  • Antonio Cabrales

    (University College London)

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.

Suggested Citation

  • Piero Gottardi & Fernando Vega-Redondo & Antonio Cabrales, 2014. "Risk Sharing and Contagion in Networks," 2014 Meeting Papers 278, Society for Economic Dynamics.
    • Handle: RePEc:red:sed014:278
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    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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