Abstract
We investigate network formation for a set of financial institutions represented as nodes. Linkages are source of income, and at the same time they bear the risk of contagion. The optimal connectivity of the nodes results from a game, in which the risk of contagion depends on the choices of all nodes in the system. Our financial network model can be interpreted as a set of banks connected through funding relations, in which a node’s threshold to contagion is represented by its external funding capacity. A second interpretation is that of a set of insurers connected through reinsurance contracts, in which the threshold to contagion is represented by their capital. Our results show that when the threshold distribution across the nodes has higher variance, then, in equilibrium, the average connectivity is in general increasing, but the link failure probability decreases. This suggests that financial stability is best described in terms of the mechanism of network formation than in terms of simple statistics of the network topology like the average connectivity.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
