Credit Freezes, Equilibrium Multiplicity, and Optimal Bailouts in Financial Networks

Matthew Jackson and Agathe Pernoud

The Review of Financial Studies, 2024, vol. 37, issue 7, 2017-2062

Abstract: We analyze how interdependencies in financial networks can lead to self-fulfilling insolvencies and multiple possible equilibrium outcomes. Multiplicity arises if a certain type of dependency cycle exists in the network. We show that finding the cheapest bailout policy that prevents self-fulfilling insolvencies is computationally hard, but that the optimal policy has intuitive features in some typical network structures. Leveraging indirect benefits ensures systemic solvency at a cost that never exceeds half of the overall shortfall. In core-periphery networks, it is optimal to bail out peripheral banks first as opposed to core banks.

Keywords: D85; G11; G32; G33; G38 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Credit Freezes, Equilibrium Multiplicity, and Optimal Bailouts in Financial Networks (2023)
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