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Structural default model with mutual obligations

Author

Listed:
  • Andrey Itkin

    (Bank of America
    New York University, School of Engineering)

  • Alexander Lipton

    (Bank of America
    Massachusetts Institute of Technology, Connection Science
    New York University)

Abstract

In this paper we consider mutual obligations in an interconnected bank system and analyze their impact on the joint and marginal survival probabilities for individual banks. We also calculate prices of the corresponding credit default swaps and first-to-default swaps. To make the role of mutual obligations more transparent, we develop a simple structural default model with banks’ assets driven by correlated multidimensional Brownian motion with drift. We calculate closed form expressions for many quantities of interest and use them for the efficient model calibration. We demonstrate that mutual obligations have noticeable impact on the system behavior.

Suggested Citation

  • Andrey Itkin & Alexander Lipton, 2017. "Structural default model with mutual obligations," Review of Derivatives Research, Springer, vol. 20(1), pages 15-46, April.
    • Handle: RePEc:kap:revdev:v:20:y:2017:i:1:d:10.1007_s11147-016-9123-1
    DOI: 10.1007/s11147-016-9123-1
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    References listed on IDEAS

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    8. Andrey Itkin & Alexander Lipton, 2014. "Efficient solution of structural default models with correlated jumps and mutual obligations," Papers 1408.6513, arXiv.org, revised Nov 2014.
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    Citations

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    Cited by:

    1. Alexander Lipton, 2020. "Old Problems, Classical Methods, New Solutions," Papers 2003.06903, arXiv.org.
    2. Alexander Lipton, 2016. "Modern Monetary Circuit Theory, Stability Of Interconnected Banking Network, And Balance Sheet Optimization For Individual Banks," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(06), pages 1-57, September.
    3. Alexander Lipton, 2015. "Modern Monetary Circuit Theory, Stability of Interconnected Banking Network, and Balance Sheet Optimization for Individual Banks," Papers 1510.07608, arXiv.org.
    4. Zachary Feinstein & Andreas Sojmark, 2019. "A Dynamic Default Contagion Model: From Eisenberg-Noe to the Mean Field," Papers 1912.08695, arXiv.org.
    5. Vadim Kaushansky & Alexander Lipton & Christoph Reisinger, 2016. "Numerical analysis of an extended structural default model with mutual liabilities and jump risk," Papers 1701.00030, arXiv.org.
    6. Tathagata Banerjee & Zachary Feinstein, 2018. "Pricing of debt and equity in a financial network with comonotonic endowments," Papers 1810.01372, arXiv.org, revised Sep 2021.
    7. Christa Cuchiero & Christoph Reisinger & Stefan Rigger, 2021. "Optimal bailout strategies resulting from the drift controlled supercooled Stefan problem," Papers 2111.01783, arXiv.org, revised Oct 2022.
    8. Vadim Kaushansky & Alexander Lipton & Christoph Reisinger, 2017. "Transition probability of Brownian motion in the octant and its application to default modeling," Papers 1801.00362, arXiv.org, revised May 2018.
    9. Alexander Lipton & Vadim Kaushansky & Christoph Reisinger, 2018. "Semi-analytical solution of a McKean-Vlasov equation with feedback through hitting a boundary," Papers 1808.05311, arXiv.org, revised Aug 2018.

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