Optimal Bailouts in Diversified Financial Networks
Theoretical Economics
2024-06-19 v1 Social and Information Networks
Abstract
Widespread default involves substantial deadweight costs which could be countered by injecting capital into failing firms. Injections have positive spillovers that can trigger a repayment cascade. But which firms should a regulator bailout so as to minimize the total injection of capital while ensuring solvency of all firms? While the problem is, in general, NP-hard, for a wide range of networks that arise from a stochastic block model, we show that the optimal bailout can be implemented by a simple policy that targets firms based on their characteristics and position in the network. Specific examples of the setting include core-periphery networks.
Cite
@article{arxiv.2406.12818,
title = {Optimal Bailouts in Diversified Financial Networks},
author = {Krishna Dasaratha and Santosh Venkatesh and Rakesh Vohra},
journal= {arXiv preprint arXiv:2406.12818},
year = {2024}
}