  This paper investigates the endogenous formation of supply chains and its
consequences for disruption propagation. In production networks where upstream
risk is highly correlated and supplier relationships are not observable, the
marginal risk reduction of adding an additional supplier is low, because this
additional supplier's risk is likely to be correlated to that of the firm's
existing suppliers. This channel reduces firm incentives to diversify, which
gives rise to inefficiently fragile production networks.
  By solving the social planner problem, I show that, if the risk reduction
experienced downstream resulting from upstream diversification were to be
internalised by upstream firms, endogenous production networks would be
resilient to most levels of risk. Furthermore, I show that imperfect
information yields inefficient but more robust supply chains. Despite its
stylised form, the model identifies the trade-off firms face when diversifying
risk and isolates the mechanism that aggregates these decisions into a
production network. Furthermore, it maps the conditions of the trade-off, such
as expected profits of the firm or the sourcing costs, to the properties of the
production network.
