Network Formation and Financial Fragility
17 Pages Posted: 16 Aug 2014
Date Written: May 6, 2014
A tractable model of the formation of financial networks is developed, allowing the use of concepts from portfolio theory. The optimal financial network maximizes a Sharpe ratio defined for financial networks, whereas the equilibrium financial network emerges from banks bargaining over future proceeds of co-investment opportunities. Measures of financial fragility, systemic risk and robustness are developed. The equilibrium financial network is shown to be the most connected and with the lowest level of financial fragility, whereas the optimal is the one least connected and with lowest exposure to systemic risk, being also the most robust financial network.
Keywords: Government intervention, financial fragility, financial networks, systemic risk, robustness
JEL Classification: G1, G2, G3
Suggested Citation: Suggested Citation