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Pricing of Corporate and Portfolio Securities in Buyer-Supplier Networks

by Gorazd Brumen of the University of Zürich, and
Paolo Vanini of the University of Zürich & Zürcher Kantonalbank

May 19, 2006

Abstract: The paper investigates how buyer-supplier firm-specific relationships affect security prices. Starting from the empirical inconsistencies in some standard structural models we propose a structural model of firm dependence in a vertically connected network of firms based on cash flow transfers between the buyers and the suppliers. A closed economy network completeness depends only on the topology of the network. We develop analytical formulas for corporate debt, credit default swaps and collateralized debt obligations. We prove that network disintegration does not necessarily reduce corporate and portfolio yields. In fact, it can raise them if the externally generated cash flows and internal network flows are positively correlated.

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