Correlated Risks vs Contagion in Stochastic Transition Models
AbstractThere 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 InfoPaper provided by Centre de Recherche en Economie et Statistique in its series Working Papers with number 2012-07.
Date of creation: Mar 2012
Date of revision:
Risk Dependence; Frailty; Systematic Risk; Contagion; Count Process; INAR Model; Compound Autoregressive Process; Affine Model; Credit Risk; Granularity Adjustment; Stochastic Intensity.;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Longitudinal Data; Spatial Time Series
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-05-22 (All new papers)
- NEP-ETS-2012-05-22 (Econometric Time Series)
- NEP-ORE-2012-05-22 (Operations Research)
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