Fire Sales and Ex Ante Valuation of Systemic Risk: A Financial Equilibrium Networks Approach

37 Pages Posted: 2 Dec 2022

See all articles by Spiros Bougheas

Spiros Bougheas

University of Nottingham - School of Economics

Adam Spencer

The University of Nottingham

Date Written: 2022

Abstract

We introduce endogenous fire sales into a simple network model. For any given initial distribution of shocks across the network, we develop a clearing algorithm to solve for the financial equilibrium. We then utilise the results to perform ex ante risk assessment and derive risk premia for every balance sheet item where liabilities are differentiated according to priority rights. We find that risk premia reflect both idiosyncratic risk and risk of contagion (network risk). Moreover, we show that network risk magnifies the gap between the risk premia of equity and debt. We also perform comparative statics, showing that changes to the distribution of shocks and network structure can have substantial effects on the level of systemic losses.

Keywords: networks, fire sales, systemic risk premia, risk assessment

JEL Classification: G330, G320, D850

Suggested Citation

Bougheas, Spiros and Spencer, Adam, Fire Sales and Ex Ante Valuation of Systemic Risk: A Financial Equilibrium Networks Approach (2022). CESifo Working Paper No. 10111, Available at SSRN: https://ssrn.com/abstract=4291745 or http://dx.doi.org/10.2139/ssrn.4291745

Spiros Bougheas (Contact Author)

University of Nottingham - School of Economics ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

Adam Spencer

The University of Nottingham ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

HOME PAGE: http://adamhalspencer.com

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