Review of Financial Studies Vol. 37 No. 7 2024
Credit Freezes, Equilibrium Multiplicity, and Optimal Bailouts in Financial Networks
Abstract
We analyze how interdependencies in financial networks can lead to self-fulfilling insolvencies and multiple possible equilibrium outcomes. Multiplicity arises if a certain type of dependency cycle exists in the network. We show that finding the cheapest bailout policy that prevents self-fulfilling insolvencies is computationally hard, but that the optimal policy has intuitive features in some typical network structures. Leveraging indirect benefits ensures systemic solvency at a cost that never exceeds half of the overall shortfall. In core-periphery networks, it is optimal to bail out peripheral banks first as opposed to core banks.
- DOI
- 10.1093/rfs/hhad096
- Volume
- 37
- Issue
- 7
- Pages
- 2017-2062
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref