Working Paper: NBER ID: w30270
Authors: Arun G. Chandrasekhar; Robert Townsend; Juan Pablo Xandri
Abstract: Consider an economy in which agents face income risk but interact in a stochastic financial network where the randomness is dictated by both chance and choice. We study the financial centrality of an agent defined as the ex-ante marginal social value of providing a small liquid asset to that agent. We show financially central agents are not only those who are linked often, but are more likely to be linked when (i) the realized network is fragmented, (ii) income risk is high, (iii) shocks are positively correlated, (iv) attitudes toward risk are more sensitive in the aggregate, and (v) there are tail risks. We apply our framework to models of financial markets with participation shocks, supply chains subject to disruptions, and village risk-sharing networks. We also study how the stochastic financial network structure influences bargaining, thereby endogenizing Pareto weights in the planner's problem. Evidence from Thai villages is consistent with these bargaining foundations, showing that agents who are more central indeed receive greater Pareto weight. We conclude by examining the welfare consequences of targeting larger liquid assets to key traders in markets, and to the most liquidity-sensitive links in supply chains.
Keywords: Liquidity; Financial Centrality; Risk Sharing; Stochastic Financial Network
JEL Codes: D14; E44; G01; L14; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial centrality (G29) | likelihood of agents being linked (L85) |
| high income risk (G52) | likelihood of agents being linked (L85) |
| fragmented networks (D85) | likelihood of agents being linked (L85) |
| positively correlated shocks (E32) | likelihood of agents being linked (L85) |
| heightened sensitivity to risk (G41) | likelihood of agents being linked (L85) |
| tail risks (D81) | likelihood of agents being linked (L85) |
| financial centrality (G29) | bargaining power (C79) |
| financial centrality (G29) | market efficiency (G14) |
| financial centrality (G29) | risk-sharing outcomes (D16) |