Large portfolio losses: A dynamic contagion model

Details Large portfolio losses: A dynamic contagion model Large portfolio losses: A dynamic contagion model

2007-04-11

arxiv.org/abs/0704.1348v3

Annals of Applied Probability 2009, Vol. 19, No. 1, 347-394

Economy

Quantitative Finance

Risk Management

Published in at http://dx.doi.org/10.1214/08-AAP544 the Annals of Applied Probability (http://www.imstat.org/aap/) by the Inst

Scientific paper

10.1214/08-AAP544

Using particle system methodologies we study the propagation of financial distress in a network of firms facing credit risk. We investigate the phenomenon of a credit crisis and quantify the losses that a bank may suffer in a large credit portfolio. Applying a large deviation principle we compute the limiting distributions of the system and determine the time evolution of the credit quality indicators of the firms, deriving moreover the dynamics of a global financial health indicator. We finally describe a suitable version of the "Central Limit Theorem" useful to study large portfolio losses. Simulation results are provided as well as applications to portfolio loss distribution analysis.

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