Resolution rules in a system of financially linked firms

The reimbursement abilities of firms holding liabilities on each other are intertwined, potentially generating coordination failures and defaults through uncontrolled contagion. In stress episodes, these linkages thus call for an orderly resolution, as implemented by a regulatory authority assigning the amount each firm within the system reimburses to each other one. The paper studies such resolution by considering 'rules', assuming their primary goal is to avoid default on external debts, say, banks' defaults on deposits. The main objective is to investigate what proportionality means for a rule, taking into account various legal and informational constraints.