Network Valuation in Financial Systems
26 Pages Posted: 16 Jun 2016 Last revised: 29 Jul 2016
Date Written: June 14, 2016
We introduce a network valuation model (hereafter NEVA) for the ex-ante valuation of claims among financial institutions connected in a network of liabilities. Similar to previous work, the new framework allows to endogenously determine the recovery rate on all claims upon the default of some institutions. In addition, it also allows to account for ex-ante uncertainty on the asset values, in particular the one arising when the valuation is carried out at some time before the maturity of the claims. The framework encompasses as special cases both the ex-post approaches of Eisenberg and Noe and its previous extensions, as well as the ex-ante approaches, in the sense that each of these models can be recovered exactly for special values of the parameters. We characterize the existence and uniqueness of the solutions of the valuation problem under general conditions on how the value of each claim depends on the equity of the counterparty. Further, we define an algorithm to carry out the network valuation and we provide sufficient conditions for convergence to the maximal solution.
Keywords: Interbank Claim Valuation; Network Valuation; Financial Network; Systemic Risk; Credit Risk; Default; Contagion
JEL Classification: D85, L14, E58, G2
Suggested Citation: Suggested Citation