A Continuous-Time Model of Financial Clearing

42 Pages Posted: 31 Jul 2020 Last revised: 14 Sep 2020

See all articles by Isaac Sonin

Isaac Sonin

affiliation not provided to SSRN

Konstantin Sonin

University of Chicago - Harris School of Public Policy; Higher School of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: September 4, 2020

Abstract

We present a simple continuous-time model of clearing in financial networks. Financial firms are represented as “tanks” filled with fluid (money), flowing in and out. Once the “pipes” connecting the “tanks” are open, the system reaches the clearing payment vector in finite time. This approach provides a simple recursive solution to a classical static model of financial clearing in bankruptcy, and suggests a practical payment mechanism. With sufficient resources, a system of mutual obligations can be restructured into an equivalent system that has a cascade structure: there is a group of banks that paid off their debts, another group that owes money only to banks in the first group, and so on. We use the machinery of Markov chains to analyze evolution of a deterministic dynamical system.

Keywords: Financial networks, clearing vector, continuous time, quasi-linear optimization

JEL Classification: G21, G33, C61

Suggested Citation

Sonin, Isaac and Sonin, Konstantin, A Continuous-Time Model of Financial Clearing (September 4, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-101, Available at SSRN: https://ssrn.com/abstract=3664060 or http://dx.doi.org/10.2139/ssrn.3664060

Isaac Sonin

affiliation not provided to SSRN

Konstantin Sonin (Contact Author)

University of Chicago - Harris School of Public Policy ( email )

1155 East 60th Street
Chicago, IL 60637
United States

Higher School of Economics ( email )

20 Myasnitskaya street
Moscow, 119017
Russia

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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