We present a simple continuous-time model of clearing in financial networks. Financial firms are represented as “tanks” filled with fluid (money), flowing in and out. Once “pipes” connecting “tanks” are open, the system reaches the clearing payment vector in finite time. This approach provides a simple recursive solution to a classical static model of financial clearing in bankruptcy, and suggests a practical payment mechanism. With sufficient resources, a system of mutual obligations can be restructured into an equivalent system that has a cascade structure: there is a group of banks that paid off their debts, another group that owes money only to banks in the first group, and so on. Technically, we use the machinery of Markov chains to analyze evolution of a deterministic dynamical system.

More Research From These Scholars

BFI Working Paper Jul 23, 2020

Persuasion on Networks

Konstantin Sonin, Georgy Egorov
BFI Working Paper Mar 23, 2020

Rebel Capacity and Combat Tactics

Konstantin Sonin, Austin Wright
BFI Working Paper Apr 25, 2020

A Political Model of Trust

Marina Agranov, Ran Eilat, Konstantin Sonin