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Seminarios académicos y conferencias

Selman Erol, Tepper School of Business, Carnegie-Mellon University

Network Hazard and Bailouts

14 Noviembre 2017 - 17:00 hrs.

Sala 209, Facultad de Ciencias Económicas y Administrativas UC

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Abstract: A theory of network formation and contagion is presented and applied to various models of financial and economic contagion. Then the impact of bailouts are studied. Time-consistent bailouts eliminate second-order counterparty risk as a by-product, which is called “network hazard”. Agents become less concerned with the counterparties of their counterparties. Network hazard makes some agents too-big-to-fail and makes the network “more core-periphery.” A larger part of the economy becomes exposed to the core, which increases volatility via the solvency of the core. It is shown that network hazard is a novel force distinct from moral hazard. Results are historically relevant to the establishment of the FED and pyramiding of reserves. The general theory presented shows that strongly stable networks exist and are almost unique in a model of threshold contagion if -an infected node’s payoff does not depend on the number of its infected neighbors and an uninfected node’s payoff decreases in the number of its infected neighbors.