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The Cambridge-INET Institute - continuing as the Janeway Institute

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Galeotti, A., Ghiglinoy , C. and Goyal, S.

Financial Linkages, Portfolio Choice and Systemic Risk

WP Number: 1602

Abstract: Financial linkages smooth the shocks faced by individual components of the system, but they also create a wedge between ownership and decision-making. The classical intuition on the role of pooling risk in raising welfare is valid when ownership is evenly dispersed. However, when the ownership of some agents is concentrated in the hands of a few others, greater integration and diversification can lead to excessive risk taking and volatility and result in lower welfare. We also show that individuals undertake too little (too much) risk relative to the first best if the network is homogeneous (heterogeneous), and study optimal networks.

Author links: Sanjeev Goyal  

PDF: wp1602.pdf

Open Access Link: 10.17863/CAM.4951

Theme: networks