Risk-Sharing and Contagion in Networks

Antonio Cabrales, Piero Gottardo and Fernando Vega-Redondo

No ECO2013/01, Economics Working Papers from European University Institute

Abstract: The aim of this paper is to investigate how the capacity of an economic system to absorb shocks depends on the specific pattern of interconnections established among financial firms. The key trade-off at work is between the risk-sharing gains enjoyed by firms when they become more interconnected and the large-scale costs resulting from an increased risk exposure. We focus on two dimensions of the network structure: the size of the (disjoint) components into which the network is divided, and the "relative density" of connections within each component. We find that when the distribution of the shocks displays "fat" tails extreme segmentation is optimal, while minimal segmentation and high density are optimal when the distribution exhibits "thin" tails. For other, less regular distributions intermediate degrees of segmentation and sparser connections are also optimal. We also find that there is typically a conflict between efficiency and pairwise stability, due to a "size externality" that is not internalized by firms who belong to components that have reached an individually optimal size. Finally, optimality requires perfect assortativity for firms in a component.

Keywords: Firm networks; Contagion; Risk Sharing (search for similar items in EconPapers)
JEL-codes: C72 D85 G21 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-ban, nep-gth and nep-net
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Journal Article: Risk Sharing and Contagion in Networks (2017)
Working Paper: Risk-Sharing and Contagion in Networks (2014)
Working Paper: Risk-sharing and contagion in networks (2014)
Working Paper: Risk Sharing and Contagion in Networks (2014)
Working Paper: Risk-sharing and contagion in networks (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eui:euiwps:eco2013/01

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