Asset Pricing in Network Economies with Systemic Risk

65 Pages Posted: 21 Nov 2017 Last revised: 20 Apr 2018

See all articles by Andrea Buraschi

Andrea Buraschi

University of Chicago - Booth School of Business; 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 propagate over time. We show the existence of two classes of equilibria. In the fi rst, firm speci fic shocks are diversifi able and standard Lucas valuation formulas apply. In the second, shocks propagate becoming endemic and non-diversi fiable, so that the cross-section of expected returns depends on rm exposure to systemic risks in ways that depend on network topology. As an application, we discuss asset pricing in a dynamic extension of the interbank network of Acemoglu, Ozdaglar and Tahbaz-Salehi (2015). For large debt levels the equilibrium becomes supercritical. Cascades of shocks induce an interbank spread over the risk free rate, increase the cost of equity capital of interconnected financial institutions and rationalize the empirically documented bank sector size premium. Finally, we discuss how financial sector concentration affects the trade-off between network stability and resilience.

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

JEL Classification: D9, E3, E4, G12

Suggested Citation

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

Andrea Buraschi (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
7738347123 (Phone)

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

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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