Pricing of Corporate and Portfolio Securities in Buyer-Supplier Networks

The paper investigates how buyer-supplier firm-specific relationships affect security prices. Starting from the empirical inconsistencies associated with 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. We prove that financial market completeness in a closed network economy depends only on the topology of the network. We develop analytical formulas for corporate debt, credit default swaps and collateralized debt obligations by decomposing the risk structure arisingfrom buy-supply orders and that arising from exogeneous sources of firm income. We prove that there exists an optimal level of firm network dependence.