Cascades in Networks and Aggregate Volatility

51 Pages Posted: 8 Nov 2010

See all articles by Daron Acemoglu

Daron Acemoglu

Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Asuman E. Ozdaglar

Massachusetts Institute of Technology (MIT) - Department of Electrical Engineering and Computer Science

Alireza Tahbaz-Salehi

Northwestern University - Kellogg School of Management

Date Written: November 2010

Abstract

We provide a general framework for the study of cascade effects created by interconnections between sectors, firms or financial institutions. Focusing on a multi sector economy linked through a supply network, we show how structural properties of the supply network determine both whether aggregate volatility disappears as the number of sectors increases (i.e., whether the law of large numbers holds) and when it does, the rate at which this happens. Our main results characterize the relationship between first order interconnections (captured by the weighted degree sequence in the graph induced by the input-output relations) and aggregate volatility, and more importantly, the relationship between higher-order interconnections and aggregate volatility. These higher-order interconnections capture the cascade effects, whereby low productivity or the failure of a set of suppliers propagates through the rest of the economy as their downstream sectors/firms also suffer and transmit the negative shock to their downstream sectors/firms. We also link the probabilities of tail events (large negative deviations of aggregate output from its mean) to sector-specific volatility and to the structural properties of the supply network.

Suggested Citation

Acemoglu, Daron and Ozdaglar, Asuman E. and Tahbaz-Salehi, Alireza, Cascades in Networks and Aggregate Volatility (November 2010). NBER Working Paper No. w16516. Available at SSRN: https://ssrn.com/abstract=1703309

Daron Acemoglu (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Asuman E. Ozdaglar

Massachusetts Institute of Technology (MIT) - Department of Electrical Engineering and Computer Science ( email )

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Cambridge, MA 02139-4307
United States
617-324-0058 (Phone)

Alireza Tahbaz-Salehi

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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