Decentralization and Mutual Liability Rules

Abstract

This paper builds on the recent work of Groote Schaarsberg, Reijnierse and Borm (2018) on mutual liability problems. In essence, a mutual liability problem comprises a financial network in which agents may have both monetary individual assets and mutual liabilities. Here mutual liabilities reflect rightful monetary obligations from past bilateral transactions. To settle these liabilities by reallocating the individual assets, mutual liability rules are analyzed that are based on centralized bilateral transfer schemes which use a certain bankruptcy rule as its leading allocation mechanism. In this paper we derive a new characterization of mutual liability rules by taking a decentralized approach instead, which is based on a recursive individual settlement procedure. We show that for bankruptcy rules that satisfy composition, this decentralized procedure always leads to the same allocation as the one prescribed by the corresponding mutual liability rule based on centralized bilateral transfer schemes.

Keywords: Mutual Liability Rules, Individual Settlement Allocation Procedure, Decentralization, Composition Property

JEL Classification: C71, G33