Financial Contagion in Network Economies and Asset Prices

Andrea Buraschi () and Claudio Tebaldi ()
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Andrea Buraschi: Finance, Imperial College, London SW7 2AZ, United Kingdom
Claudio Tebaldi: Department of Finance, Bocconi University, 20135 Milan, Italy

Management Science, 2024, vol. 70, issue 1, 484-506

Abstract: This paper studies intertemporal asset pricing in network economies when distress shocks can propagate through the network, similarly to epidemic outbreaks. Two classes of equilibria exist. In the first, idiosyncratic shocks are diversifiable and do not affect valuations; the consumption capital asset pricing model applies. In the second, idiosyncratic shocks generate nondiversifiable long-run cascades of shocks (financial pandemics) that introduce a new risk premium component unexplained by traditional systematic factors. We derive closed solutions for asset prices as a function of the network properties and discuss their properties. After a structural break (1984), we find evidence of a network risk premium that is statistically and economically significant.

Keywords: equilibrium asset pricing; financial contagion; network economies (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:70:y:2024:i:1:p:484-506

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