Network formation and heterogeneous risks

Antonio Cabrales and Piero Gottardi

No 19089, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study a new model to study the effect of contract externalities that arise through shock transmission. We model a financial network where good firms enjoy direct and indirect benefits from linking with one another. Bad risks benefit from having a connection with a good firm, but they are a cost to both direct and indirect connections. In efficient networks the good risks should form large connected components with very few bad risks attached. The equilibrium networks, on the other hand, have many more bad risks attached, they are core-periphery structures, and components are also smaller than the efficient ones. We also study extensions with heterogenous “bad risks,†with diversity in the costs to good risk firms of linking with bad risks, and with incomplete information.

Keywords: Network; formation (search for similar items in EconPapers)
JEL-codes: D85 G21 G32 (search for similar items in EconPapers)
Date: 2024-05
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Working Paper: Network Formation and Heterogeneous Risks (2024)
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