Strategic default in financial networks

Nizar Allouch, Maya Jalloul and Alfred Duncan

Games and Economic Behavior, 2023, vol. 142, issue C, 941-954

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 and guide regulatory intervention that relies on the financial network structure. The algorithm provides a ranking for the set of Nash equilibria for specific financial network structures, 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; Ear decomposition; 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: 2023
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Working Paper: Strategic Default in Financial Networks (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:gamebe:v:142:y:2023:i:c:p:941-954

DOI: 10.1016/j.geb.2023.10.001

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