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Modeling the risks within the protocol Aave, with an application to portfolio allocation

Author

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  • Emmanuel Gobet

    (LPSM (UMR_8001) - Laboratoire de Probabilités, Statistique et Modélisation - SU - Sorbonne Université - CNRS - Centre National de la Recherche Scientifique - UPCité - Université Paris Cité)

  • Louis Latournerie

    (CMAP - Centre de Mathématiques Appliquées de l'Ecole polytechnique - Inria - Institut National de Recherche en Informatique et en Automatique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique, CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - Groupe ENSAE-ENSAI - Groupe des Écoles Nationales d'Économie et Statistique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - ENSAE Paris - École Nationale de la Statistique et de l'Administration Économique - Groupe ENSAE-ENSAI - Groupe des Écoles Nationales d'Économie et Statistique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique)

Abstract

Decentralized Finance (DeFi) lending and borrowing protocols enable investors to take leveraged long and short positions on digital assets without centralized intermediaries, but expose them to a distinctive form of risk: on-chain liquidation triggered by debt and collateral value fluctuations. In this work, we provide a detailed formalization of Aave's lending, borrowing, and liquidation mechanisms, grounded in the protocol's open-source implementation. In doing so, we propose a mathematical modeling of the risk of liquidation, including some stochastic approximations with the purpose of efficient analysis, with different applications. Among them, portfolio optimization problem.

Suggested Citation

  • Emmanuel Gobet & Louis Latournerie, 2026. "Modeling the risks within the protocol Aave, with an application to portfolio allocation," Working Papers hal-05544344, HAL.
    • Handle: RePEc:hal:wpaper:hal-05544344
    Note: View the original document on HAL open archive server: https://hal.science/hal-05544344v1
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