Pricing Effects of Crossholdings in a Network Environment

Abstract

We consider an economy of firms with cross-held securities. The value of the debt contract in such a network depends on the value of other debt contracts. This has the potential to induce contagion effects. The article proposes a Monte-Carlo algorithm to solve the problem of debt prices in an economy with crossholdings. As the number of firms in the network increases, debt yields increase only to a certain level, which we interpret as a measure of balance-sheet contagion. An increase in variance of the fundamental assets of one firm is almost totally absorbed within the debt yield of that firm. Heterogeneity of debt principals has the potential to induce large contagion effects.

Keywords: Crossholdings, network dependent securities pricing, market equilibrium with crossholdings

JEL Classification: G12, G20, C31, C02