Network Formation and Heterogeneous Risks

No 11122, CESifo Working Paper Series from CESifo

Abstract: We study a new model to study the effect of contract externalities that arise through shock transmission. We model a financial network where good firms enjoy direct and indirect benefits from linking with one another. Bad risks benefit from having a connection with a good firm, but they are a cost to both direct and indirect connections. In efficient networks the good risks should form large connected components with very few bad risks attached. The equilibrium networks, on the other hand, have many more bad risks attached, they are core-periphery structures, and components are also smaller than the efficient ones. We also study extensions with heterogenous “bad risks,” with diversity in the costs to good risk firms of linking with bad risks, and with incomplete information.

Keywords: network formation; financial shocks; financial contagion; core periphery; efficiency and equilibrium (search for similar items in EconPapers)
JEL-codes: D85 G21 G32 (search for similar items in EconPapers)
Date: 2024
New Economics Papers: this item is included in nep-cfn, nep-gth and nep-net
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Working Paper: Network formation and heterogeneous risks (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_11122

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