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Regional shocks and the formation of interconnected markets: A network approach

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  • Joshi, Sumit
  • Mahmud, Ahmed Saber

Abstract

We examine the strategic incentives of a set of regions, inhabited by risk-averse agents, to form interconnected markets to: (i) diversify the risk arising from random shocks to endowments, and (ii) gain from exchange. We characterize the equilibrium architecture of interconnected markets. Of particular import is the issue of heterogeneity, and we characterize the equilibrium size and composition of interconnected markets with respect to heterogeneity in variances and covariances of shocks across regions. We then compare the equilibrium architecture of interconnected markets to that derived from a pure risk diversification mechanism such as income-sharing. We also characterize the efficient architecture that maximizes aggregate utility.

Suggested Citation

  • Joshi, Sumit & Mahmud, Ahmed Saber, 2021. "Regional shocks and the formation of interconnected markets: A network approach," Journal of Economic Behavior & Organization, Elsevier, vol. 184(C), pages 78-98.
    • Handle: RePEc:eee:jeborg:v:184:y:2021:i:c:p:78-98
    DOI: 10.1016/j.jebo.2021.01.025
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    More about this item

    Keywords

    Risk-sharing; Income-sharing; Interconnected markets; Network formation; Pairwise stable equilibrium;
    All these keywords.

    JEL classification:

    • C71 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Cooperative Games
    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation

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