Risk-Sharing and Contagion in Networks

42 Pages Posted: 16 Apr 2014

See all articles by Antonio Cabrales

Antonio Cabrales

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Piero Gottardi

European University Institute - Department of Economics; Ca Foscari University of Venice - Dipartimento di Economia; CESifo (Center for Economic Studies and Ifo Institute)

Fernando Vega-Redondo

Bocconi University

Date Written: March 16, 2014

Abstract

We investigate the trade-off between the risk-sharing gains enjoyed by more interconnected firms and the costs resulting from an increased risk exposure. We find that when the shock distribution displays “fat” tails, extreme segmentation into small components is optimal, while minimal segmentation and high density of connections are optimal when the distribution exhibits “thin” tails. For less regular distributions, intermediate degrees of segmentation and sparser connections are optimal. Also, if firms are heterogeneous, optimality requires perfect assortativity in a component. In general, however, a conflict arises between efficiency and pairwise stability, due to a “size externality” not internalized by firms.

Keywords: firm networks, contagion, risk sharing

JEL Classification: D850, C720, G210

Suggested Citation

Cabrales, Antonio and Gottardi, Piero and Vega-Redondo, Fernando, Risk-Sharing and Contagion in Networks (March 16, 2014). CESifo Working Paper Series No. 4715. Available at SSRN: https://ssrn.com/abstract=2425558

Antonio Cabrales

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(34-93) 542 27 65 (Phone)
(34-93) 542 17 46 (Fax)

Piero Gottardi (Contact Author)

European University Institute - Department of Economics ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy
+39 041 257 4192 (Phone)
+39 041 257 4176 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Fernando Vega-Redondo

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

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