Optimal Bailouts in Diversified Financial Networks

Krishna Dasaratha, Santosh Venkatesh () and Rakesh Vohra ()
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Krishna Dasaratha: Boston University
Santosh Venkatesh: University of Pennsylvania
Rakesh Vohra: University of Pennsylvania

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: Widespread default involves substantial deadweight costs which could be countered by injecting capital into failing firms. Injections have positive spillovers that can trigger a repayment cascade. But which firms should a regulator bailout so as to minimize the total injection of capital while ensuring solvency of all firms? While the problem is, in general, NP-hard, for a wide range of networks that arise from a stochastic block model, we show that the optimal bailout can be implemented by a simple policy that targets firms based on their characteristics and position in the network. Specific examples of the setting include core-periphery networks.

JEL-codes: C62 D85 F65 G32 G33 G38 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2024-09-14
New Economics Papers: this item is included in nep-cfn and nep-net
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