FINANCIAL CONTAGION IN NETWORK ECONOMIES AND ASSET PRICES
59 Pages Posted: 21 Nov 2017 Last revised: 6 May 2020
Date Written: November 19, 2017
This paper studies intertemporal asset pricing in network economies when distress shocks can propagate through the network, similarly to epidemic outbreaks. Two classes of equilibria exist. In the first, idiosyncratic shocks are diversifiable and do not affect investor asset valuations. The CCAPM applies. In the second, idiosyncratic shocks can generate non-diversifiable long-run cascades of shocks (financial pandemics) that introduce a new risk premium component which is
not explained by traditional systematic factors. We present a methodology that allows to derive closed-solutions for asset prices as a function of the properties of the network and to discuss their properties.
Keywords: Network, asset pricing, systemic risk, contagion, epidemics, cascades
JEL Classification: D9, E3, E4, G12
Suggested Citation: Suggested Citation