Credit Risk and the Instability of the Financial System: an Ensemble Approach
AbstractThe instability of the financial system as experienced in recent years and in previous periods is often linked to credit defaults, i.e., to the failure of obligors to make promised payments. Given the large number of credit contracts, this problem is amenable to be treated with approaches developed in statistical physics. We introduce the idea of ensemble averaging and thereby uncover generic features of credit risk. We then show that the often advertised concept of diversification, i.e., reducing the risk by distributing it, is deeply flawed when it comes to credit risk. The risk of extreme losses remain due to the ever present correlations, implying a substantial and persistent intrinsic danger to the financial system.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1309.5245.
Date of creation: Sep 2013
Date of revision: Nov 2013
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-09-25 (All new papers)
- NEP-CBA-2013-09-25 (Central Banking)
- NEP-FMK-2013-09-25 (Financial Markets)
- NEP-LAM-2013-09-25 (Central & South America)
- NEP-LTV-2013-09-25 (Unemployment, Inequality & Poverty)
- NEP-NEU-2013-09-25 (Neuroeconomics)
- NEP-RMG-2013-09-25 (Risk Management)
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