MACRO: Financial Market Structure and Risk Concentration; Professor Briana Chang (Wisconsin School of Business)

Abstract

We present a framework that jointly determines trading networks and risk allocation among banks. Banks are ex-ante homogeneous and risk-averse, but their marginal costs of bearing risks may be diminishing. The optimal trading network is determined by the tradeoff between risk sharing vs. concentration, which in turn determines the level of aggregate risk exposures, amount of intermediate trades, dispersion of transaction prices and distribution of risk exposure across financial institutions. We show that a continuous change in fundamentals or regulations may lead to a structural change in the market structure, causing discontinuous changes in these observables.

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