A Strategic Analysis of Prepayments in Financial Credit Networks

Abstract

In financial credit networks, prepayments enable a firm to settle its debt obligations ahead of an agreed-upon due date. Prepayments have a transformative impact on the structure of networks, influencing the financial well-being (utility) of individual firms. This study investigates prepayments from both theoretical and empirical perspectives. We first establish the computational complexity of finding prepayments that maximize welfare, assuming global coordination among firms in the financial network. Subsequently, our focus shifts to understanding the strategic behavior of individual firms in the presence of prepayments. We introduce a prepayment game where firms strategically make prepayments, delineating the existence of pure strategy Nash equilibria and analyzing the price of anarchy (stability) within this game. Recognizing the computational challenges associated with determining Nash equilibria in prepayment games, we use a simulation-based approach, known as empirical game-theoretic analysis (EGTA). Through EGTA, we are able to find Nash equilibria among a carefully-chosen set of heuristic strategies. By scrutinizing the equilibrium behavior of firms, we outline the characteristics of high-performing strategies for strategic prepayments and establish connections between our empirical and theoretical findings.