Efficient Contracting in Network Financial Markets

We model bargaining in over-the-counter network markets over the terms and prices of contracts. Of concern is whether bilateral non-cooperative bargaining is suÿcient to achieve eÿciency in this multilateral setting. For example, will market participants as-sign insolvency-based seniority in a socially eÿcient manner, or should bankruptcy laws override contractual terms with an automatic stay? We provide conditions under which bilateral bargaining over contingent contracts is eÿcient for a network of market partic-ipants. Examples include seniority assignment, close-out netting and collateral rights, secured debt liens, and leverage-based covenants. Given the ability to use covenants and other contingent contract terms, central market participants eÿciently internalize the costs and benefits of their counterparties through the pricing of contracts. We provide counterexamples to eÿciency for less contingent forms of bargaining coordination.