Strategic Default in Financial Networks

Nizar Allouch, Maya Jalloul and Alfred Duncan

Studies in Economics from School of Economics, University of Kent

Abstract: This paper investigates a model of default in financial networks where the decision by one agent on whether or not to default impacts the incentives of other agents to escape default. Agents' payoffs are determined by the clearing mechanism introduced in the seminal contribution of Eisenberg and Noe (2001). We first show the existence of a Nash equilibrium of this default game. Furthermore, we develop an algorithm to find all Nash equilibria that relies on the financial network structure. The algorithm provides a ranking for the set of Nash equilibria, which can serve as a measure of systemic risk. Finally, we show that introducing a central clearing counterparty achieves the efficient equilibrium at no additional cost.

Keywords: systemic risk, default; financial networks; coordination games; central clearing counterparty; financial regulation (search for similar items in EconPapers)
JEL-codes: C72 D53 D85 G21 G28 G33 (search for similar items in EconPapers)
Date: 2021-08
New Economics Papers: this item is included in nep-net and nep-ore
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https://www.kent.ac.uk/economics/repec/2111.pdf (application/pdf)

Related works:
Journal Article: Strategic default in financial networks (2023)
Working Paper: Strategic Default in Financial Networks (2018)
Working Paper: Strategic Default in Financial Networks (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:ukc:ukcedp:2111

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