Parent node does not update when updating referenced entity child node
When the referenced child node is updated in the database this triggers automatically a cache invalidation.

In this case there are three theming levels, page, parent node and child node. They all need to be invalidated when an entity involved gets updated. 

But this only works when they are tagged properly. You only need to have the children tagged, because tags bubble up to the parent.

For debugging check the response header X-Drupal-Cache-Tags. To enable this header copy sites/default/default.services.yml to services.ymland set:

  # Cacheability debugging:
  #
  # Responses with cacheability metadata (CacheableResponseInterface instances)
  # get X-Drupal-Cache-Tags and X-Drupal-Cache-Contexts headers.
  #
  # For more information about debugging cacheable responses, see
  # https://www.drupal.org/developing/api/8/response/cacheable-response-interface
  #
  # Not recommended in production environments
  # @default false
  http.response.debug_cacheability_headers: true


Now you can check the response headers in the browser debugging tools and see which cache tags are missing in the page.