Asset Pricing Implications of Systemic Risk in Network Economies

70 Pages Posted: 21 Nov 2017 Last revised: 16 Jul 2019

See all articles by Andrea Buraschi

Andrea Buraschi

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance; Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Date Written: November 19, 2017

Abstract

This paper studies inter-temporal asset pricing in network economies when distress shocks can propagate. Two classes of equilibria exists. In the first, firm speci fic shocks are diversi fiable and standard Lucas valuation formulas apply. In the second, shocks propagate and form cascades becoming endemic and non-diversi fiable. We study a dynamic extension of the interbank network of Acemoglu, Ozdaglar and Tahbaz-Salehi (2015) and characterize the link between network topology and (i) stability, (ii) economic resilience, (iii) crisis duration. Financial sector concentration affects the trade-offs between network stability and resilience, and between probability and duration of a crisis. Large debt levels can trigger cascades of shocks, inducing larger interbank (Libor) spreads and cost of equity capital of peripheral nancial institutions. We derive closed-form solutions for equilibrium asset prices. Cascades induce a violation of the CAPM: idiosyncratic shocks affect expected excess returns, the cross-section of risk premia depends on rm exposure to network cascade risk and its distribution is negatively skewed.

Keywords: Network, asset pricing, systemic risk, contagion, cascades

JEL Classification: D9, E3, E4, G12

Suggested Citation

Buraschi, Andrea and Tebaldi, Claudio, Asset Pricing Implications of Systemic Risk in Network Economies (November 19, 2017). Available at SSRN: https://ssrn.com/abstract=3074012 or http://dx.doi.org/10.2139/ssrn.3074012

Andrea Buraschi (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.andreaburaschi.com/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance ( email )

Via Roentgen 1
Milan, 20136
Italy

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

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