FINANCIAL CONTAGION IN NETWORK ECONOMIES AND ASSET PRICES

This paper studies intertemporal asset pricing in network economies when distress shocks can propagate through the network, similarly to epidemic outbreaks. Two classes of equilibria exist. In the fi rst, idiosyncratic shocks are diversi fiable and do not affect investor asset valuations. The CCAPM applies. In the second, idiosyncratic shocks can generate non-diversifi able long-run cascades of shocks (fi nancial pandemics) that introduce a new risk premium component which isnot explained by traditional systematic factors. We present a methodology that allows to derive closed-solutions for asset prices as a function of the properties of the network and to discuss their properties