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Optimal Bailouts in Diversified Financial Networks

Author

Listed:
  • Krishna Dasaratha

    (Boston University)

  • Santosh S. Venkatesh

    (University of Pennsylvania)

  • Rakesh Vohra

    (University of Pennsylvania)

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.

Suggested Citation

  • Krishna Dasaratha & Santosh S. Venkatesh & Rakesh Vohra, 2024. "Optimal Bailouts in Diversified Financial Networks," PIER Working Paper Archive 24-026, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    • Handle: RePEc:pen:papers:24-026
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    More about this item

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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