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Optimal Bailouts in Diversified Financial Networks

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  • Krishna Dasaratha
  • Santosh Venkatesh
  • Rakesh Vohra

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.

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  • Krishna Dasaratha & Santosh Venkatesh & Rakesh Vohra, 2024. "Optimal Bailouts in Diversified Financial Networks," Papers 2406.12818, arXiv.org.
    • Handle: RePEc:arx:papers:2406.12818
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    References listed on IDEAS

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