Impact of Contingent Payments on Systemic Risk in Financial Networks

TL;DR

This paper explores how contingent payments influence systemic risk in financial networks, extending existing models to include dynamic interactions and conditions for unique solutions.

Contribution

It introduces a dynamic framework for analyzing contingent payments in financial networks, overcoming limitations of static models and ensuring solution existence and uniqueness.

Findings

Dynamic framework enables analysis of complex contingent payment scenarios.

Conditions for solution existence and uniqueness are established.

Application to previously ill-defined problems in static models.

Abstract

In this paper we study the implications of contingent payments on the clearing wealth in a network model of financial contagion. We consider an extension of the Eisenberg-Noe financial contagion model in which the nominal interbank obligations depend on the wealth of the firms in the network. We first consider the problem in a static framework and develop conditions for existence and uniqueness of solutions as long as no firm is speculating on the failure of other firms. In order to achieve existence and uniqueness under more general conditions, we introduce a dynamic framework. We demonstrate how this dynamic framework can be applied to problems that were ill-defined in the static framework.