Pricing Credit Risk in Buyer-Supplier Networks

50 Pages Posted: 25 Mar 2008 Last revised: 15 May 2008

See all articles by Gorazd Brumen

Gorazd Brumen

University of Zurich - Swiss Banking Institute (ISB); Princeton University - Bendheim Center for Finance

Paolo Vanini

University of Basel

Date Written: May, 13 2008

Abstract

We investigate how buyer-supplier firm-specific relationships affect security prices. We propose a structural model of firm dependence in a vertically connected network of firms based on cash flow transfers between buyers and suppliers.

We prove that financial market completeness in a closed network economy depends only on the topology of the network. We develop analytical formulas for corporate debt, credit default swaps and collateralized debt obligations. The market prices of buy risks are determined globally in the economy and induce contagion effects. The empirical test of the model on the subcontractors' network of the SwissAir Group gives the yield spread average relative prediction error of 18% compared to the 89% error of the Merton model.

Keywords: Asset pricing, network dependence models, contagion, buyer-supplier networks, credit risk.

JEL Classification: C02, C16, C65, G12, G13.

Suggested Citation

Brumen, Gorazd and Vanini, Paolo, Pricing Credit Risk in Buyer-Supplier Networks (May, 13 2008). Available at SSRN: https://ssrn.com/abstract=1107700 or http://dx.doi.org/10.2139/ssrn.1107700

Gorazd Brumen (Contact Author)

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland
+41 44 634 27 85 (Phone)
+41 44 634 49 03 (Fax)

HOME PAGE: http://www.gorazdbrumen.net

Princeton University - Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

Paolo Vanini

University of Basel ( email )

Petersplatz 1
Basel, CH-4003
Switzerland

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