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Contagion and Equlilbria in Diversified Financial Networks

Victor Amelkin (), Santosh Venkatesh () and Rakesh Vohra ()
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Victor Amelkin: Amazon.com
Santosh Venkatesh: University of Pennsylvania
Rakesh Vohra: University of Pennsylvania

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: Diversified cross-shareholding networks are thought to be more resilient to shocks, but diversification also increases the channels by which a shock can spread. To resolve these competing intuitions we introduce a stochastic model of a diversified cross-shareholding network in which a firm’s valuation depends on its cash endowment and the shares it owns in other firms. We show that a concentration of measure phenomenon emerges: almost all realized network instances drawn from any probability distribution in a wide class are resilient to contagion if endowments are sufficiently large. Furthermore, the size of a shock needed to trigger widespread default increases with the exposure of firms to each other. Distributions in this class are characterized by the property that a firm’s equity shares owned by others are weakly dependent yet lack “dominant” shareholders.

Keywords: financial network; random network; contagion; systemic risk; equilibrium; dynamics; concentration of measure (search for similar items in EconPapers)
Pages: 72 pages
Date: 2021-11-30
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