Models of network formation and financial contagion

In this Thesis we study two features of production networks: their emergence and their vulnerability to idiosyncratic shocks. In order to understand the relation between economic incentives leading to the formation and the systemic properties of the network we map our economic analysis into the mathematical theory of networks.In the first Chapter we develop a simple model of endogenous formation of input-output economies to address the theoretical nexus between trade-credit, bank credit and credit contagion. We make two contributions. First, we show that competitive markets in which heterogeneous price-taker firms compete strategically by setting trade-credit maturities have a unique symmetric equilibrium in trade-terms and the equilibrium dictates the production flow along the supply chains. Secondly, we find that the network can have a role either as shock absorber or shock amplifier and this is determined by a testable condition which holds for a general class of trade-credit networks. On these grounds, we argue that the proportional credit rationing used by banks (i.e., richer borrowers obtain larger loans) may have ambiguous effects on systemic vulnerability.In the second Chapter we develop a model of economic networks formation which links Internal Capital Markets to the formation of Business Groups. Our model is stylized as it focuses on two interacting channels: the debt-to-equity regulations and investment profitability. In our model, a growing group of heterogeneous and financially constrained firms have a limited capability to coordinate production in a competitive market by means of pairwise credit arrangements. We show that usage of inter-firm credit is sustained by an individually rational mechanism which match several empirical features.In the third Chapter, we look at the complex effects of financial frictions in a non-stationary market economy with heterogeneous agents. We study two classes of dynamic equilibria for which the market converges to the expression of a single type of seller