Regional shocks and the formation of interconnected markets: A network approach

Sumit Joshi and Ahmed Saber Mahmud

Journal of Economic Behavior & Organization, 2021, vol. 184, issue C, 78-98

Abstract: We examine the strategic incentives of a set of regions, inhabited by risk-averse agents, to form interconnected markets to: (i) diversify the risk arising from random shocks to endowments, and (ii) gain from exchange. We characterize the equilibrium architecture of interconnected markets. Of particular import is the issue of heterogeneity, and we characterize the equilibrium size and composition of interconnected markets with respect to heterogeneity in variances and covariances of shocks across regions. We then compare the equilibrium architecture of interconnected markets to that derived from a pure risk diversification mechanism such as income-sharing. We also characterize the efficient architecture that maximizes aggregate utility.

Keywords: Risk-sharing; Income-sharing; Interconnected markets; Network formation; Pairwise stable equilibrium (search for similar items in EconPapers)
JEL-codes: C71 D51 D85 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:184:y:2021:i:c:p:78-98

DOI: 10.1016/j.jebo.2021.01.025

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