Financial Contagion and Asset Liquidation Strategies

This paper provides a framework for modeling the financial system with multiple illiquid assets during a crisis. This extends the network model of Cifuentes, Shin & Ferrucci (2005) that incorporates a single asset with fire sales. We prove sufficient conditions for the existence and uniqueness of equilibrium clearing payments and liquidation prices. We prove sufficient conditions for the existence of an equilibrium liquidation strategy with corresponding clearing payments and liquidation prices. The number of defaults and wealth of the real economy under different investment and liquidation strategies are analyzed in several comparative case studies. Notably we investigate the effects that diversification has on the health of the financial system during a crisis.