Financial Contagion in Networks: A Market Experiment
73 Pages Posted: 5 Jul 2017 Last revised: 15 Nov 2017
Date Written: June 27, 2017
We investigate how the network structure of financial linkages and uncertainty about the location of a shock affect the likelihood of contagion and the formation of prices in a double auction market experiment. Core-periphery networks are highly susceptible to contagion and generate fire sales of assets that exacerbate financial contagion beyond the mechanical role of network structure. In contrast, contagion is minimal on circle networks and market prices remain stable. Uncertainty on the location of the shock has little influence. The traders' comprehension level of the network-driven risk is predictive of their behavior and the likelihood of bankruptcy.
Keywords: contagion, financial network, experimental asset market
JEL Classification: C92, D40, D85, L14
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