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Risk-sharing and contagion in networks

Cabrales, A; Gottardi, P; Vega-Redondo, F; (2017) Risk-sharing and contagion in networks. Review of Financial Studies , 30 (9) pp. 3086-3127. 10.1093/rfs/hhx077. Green open access

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We investigate the socially optimal design of financial networks, that allows to tackle the trade-off between risk sharing and contagion. We identify conditions on the shock distribution under which full integration or maximal segmentation is optimal. We also show that, under different conditions, the optimal network displays different levels of strength of linkages to other firms or intermediate degrees of segmentation. In the latter case, the individual and social incentives to establish linkages are not necessarily aligned. When firms face heterogeneous distributions of risks, they should optimally form linkages only with firms facing risks of the same kind.

Type: Article
Title: Risk-sharing and contagion in networks
Open access status: An open access version is available from UCL Discovery
DOI: 10.1093/rfs/hhx077
Publisher version: http://doi.org/10.1093/rfs/hhx077
Language: English
Additional information: This version is the author accepted manuscript. For information on re-use, please refer to the publisher’s terms and conditions.
Keywords: G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages D85 - Network Formation and Analysis: Theory C72 - Noncooperative Games
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/1556274
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