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Correlated Risks vs Contagion in Stochastic Transition Models

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  • Patrick Gagliardini

    ()
    (University of Lugano)

  • Christian Gouriéroux

    ()
    (CREST, University of Toronto)

Abstract

There is a growing literature on the possibility to identify correlation and contagion in qualitative risk analysis. Our paper considers this question by means of a model describing the joint dynamics of a set of individual binary processes. The two admissible values correspond to bad and good risk states of an individual. The risk correlation and its time dependence are captured by introducing a dynamic frailty, whereas the contagion passes through the effect of the lagged number of individuals in the bad risk state. We study carefully the dynamic properties of the joint process. Then, we focus on the limiting case of large populations (portfolios) and reconcile the microscopic and macroscopic dynamic views of the risk. The difficulty to identify in finite sample risk correlation and contagion is illustrated by means of Monte-Carlo simulations

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Bibliographic Info

Paper provided by Centre de Recherche en Economie et Statistique in its series Working Papers with number 2012-07.

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Length: 62
Date of creation: Mar 2012
Date of revision:
Handle: RePEc:crs:wpaper:2012-07

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Keywords: Risk Dependence; Frailty; Systematic Risk; Contagion; Count Process; INAR Model; Compound Autoregressive Process; Affine Model; Credit Risk; Granularity Adjustment; Stochastic Intensity.;

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  1. Upper, Christian & Worms, Andreas, 2004. "Estimating bilateral exposures in the German interbank market: Is there a danger of contagion?," European Economic Review, Elsevier, vol. 48(4), pages 827-849, August.
  2. Philipp J. Schönbucher, 2000. "Factor Models for Portofolio Credit Risk," Bonn Econ Discussion Papers bgse16_2001, University of Bonn, Germany.
  3. Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
  4. Egloff, Daniel & Leippold, Markus & Vanini, Paolo, 2007. "A simple model of credit contagion," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2475-2492, August.
  5. Didier Rulli\`ere & Diana Dorobantu & Areski Cousin, 2009. "An extension of Davis and Lo's contagion model," Papers 0904.1653, arXiv.org, revised Feb 2010.
  6. Giampiero Gallo & Edoardo Otranto, 2006. "Volatility Transmission Across Markets: A Multi-Chain Markov Switching Model," Econometrics Working Papers Archive wp2006_04, Universita' degli Studi di Firenze, Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti".
  7. Yacine Aït-Sahalia & Julio Cacho-Diaz & Roger J.A. Laeven, 2010. "Modeling Financial Contagion Using Mutually Exciting Jump Processes," NBER Working Papers 15850, National Bureau of Economic Research, Inc.
  8. Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
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