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arXiv · 2406.12818

Optimal Bailouts in Diversified Financial Networks

Krishna Dasaratha·Santosh Venkatesh·Rakesh Vohra
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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.

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Krishna Dasaratha, Santosh Venkatesh, Rakesh Vohra. 2024-06-18. Optimal Bailouts in Diversified Financial Networks. https://arxiv.org/abs/2406.12818

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