Larry Blume, Cornell University

The Fin­ance Brown Bag Sem­inar is held by the In­sti­tute for Fin­ance, Bank­ing and In­sur­ance (WU Vi­enna) and the Vi­enna Gradu­ate School of Fin­ance (VGSF). It serves as a present­a­tion plat­form for PhD stu­dents, fac­ulty mem­bers, and vis­it­ors. An over­view of BBS on the web­site of the In­sti­tute for Fin­ance, Bank­ing and In­sur­ance.

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Larry Blume, Cor­nell Uni­versity

Net­work Form­a­tion in the Pres­ence of Con­ta­gious Risk

There are a num­ber of do­mains where agents must col­lect­ively form a net­work in the face of the fol­low­ing trade-off: each agent re­ceives be­ne­fits from the dir­ect links it forms to oth­ers, but these links ex­pose it to the risk of be­ing hit by a cas­cad­ing fail­ure that might spread over mul­tistep paths. Fin­an­cial con­ta­gion, epidemic dis­ease, the ex­pos­ure of cov­ert or­gan­iz­a­tions to dis­cov­ery, and elec­trical power net­works are all set­tings in which such is­sues have been ar­tic­u­lated. Here we for­mu­late the prob­lem in terms of stra­tegic net­work form­a­tion, and provide asymp­tot­ic­ally tight bounds on the wel­fare of both op­timal and stable net­works. We find that so­cially op­timal net­works are, in a pre­cise sense, situ­ated just bey­ond a phase trans­ition in the be­ha­vior of the cas­cad­ing fail­ures, and that stable graphs lie slightly fur­ther bey­ond this phase trans­ition, at a point where most of the avail­able wel­fare has been lost. Our ana­lysis en­ables us to ex­plore such is­sues as the trade-offs between clustered and an­onym­ous mar­ket struc­tures, and it ex­poses a fun­da­mental sense in which very small amounts of “over­-link­ing” in net­works with con­ta­gious risk can have strong con­sequences for the wel­fare of the par­ti­cipants.