Bilateral Contracting in Network Financial Markets

Stanford University, Stanford CA

Investigators

Abstract

We exploit and generalize existing axiomatic and non-­cooperative theories of bilateral bargaining, going back to non-­network based theories of John Nash and Ariel Rubinstein. The broad impact of this project is the potential improvement of allocative efficeincy in arange of network-based markets that operate through bilateral negotaition, and the identfication of settings in which bilateral bargaining over contracts is inefficeint. We extend trembling-hand type equilibrium refinemnet concepts to alternating offer games, and extend axioms for solutions of network-based bilateral bargaining problems. This project will extend the theory of bilateral contracting in network markets, such as over-the-counter markets for corporate debt and bilateral derivatives including swaps. The goal is to better distinguish conditions, including bargaining protocols, under which bilateral contracting is socially efficient, constrained by the network structure of market relationships and the menus of network-compatible contractible actions. An example is the identification of situations in which contracting between corporations and financial institutions will assign a bankrupt firm's assets to its creditors and swap counterparties in an efficient manner. If not the bankruptcy code should be used to override bilaterally negotiated contractual treatments. Bankruptcy stays can trump rights of termination, collateral, closeout netting, and assignment of insolvency priority. Statutes can give courts or insolvency administrators the right to stay contracts at insolvency and claw back inefficient transfers that occurred prior to insolvency.