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Valuation Algorithms for Structural Models of Financial Interconnectedness

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  • Johannes Hain
  • Tom Fischer

Abstract

Much research in systemic risk is focused on default contagion. While this demands an understanding of valuation, fewer articles specifically deal with the existence, the uniqueness, and the computation of equilibrium prices in structural models of interconnected financial systems. However, beyond contagion research, these topics are also essential for risk-neutral pricing. In this article, we therefore study and compare valuation algorithms in the standard model of debt and equity cross-ownership which has crystallized in the work of several authors over the past one and a half decades. Since known algorithms have potentially infinite runtime, we develop a class of new algorithms, which find exact solutions in finitely many calculation steps. A simulation study for a range of financial system designs allows us to derive conclusions about the efficiency of different numerical methods under different system parameters.

Suggested Citation

  • Johannes Hain & Tom Fischer, 2015. "Valuation Algorithms for Structural Models of Financial Interconnectedness," Papers 1501.07402, arXiv.org.
    • Handle: RePEc:arx:papers:1501.07402
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    References listed on IDEAS

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    1. Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
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    Cited by:

    1. Paolo Barucca & Marco Bardoscia & Fabio Caccioli & Marco D'Errico & Gabriele Visentin & Guido Caldarelli & Stefano Battiston, 2020. "Network valuation in financial systems," Mathematical Finance, Wiley Blackwell, vol. 30(4), pages 1181-1204, October.
    2. Nils Bertschinger & Julian Stobbe, 2018. "Systemic Greeks: Measuring risk in financial networks," Papers 1810.11849, arXiv.org.
    3. Nils Bertschinger & Axel A. Araneda, 2021. "Cross-ownership as a structural explanation for rising correlations in crisis times," Papers 2112.04824, arXiv.org.

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