Stochastic Cascades, Credit Contagion, and Large Portfolio Losses
Please always quote using this URN:urn:nbn:de:0296-matheon-837
- We analyze an interactive model of credit ratings where external shocks, initially affecting only a small number of firms, spread by a contagious chain reaction to the entire economy. Counterparty relationships along with discrete adjustments of credit ratings generate a transition mechanism that allows the financial distress of one firm to spill over to its business partners. Such a contagious infectious of financial distress constitutes a source of intrinsic risk for large portfolios of credit sensitive securities that cannot be “diversified away.” We provide a complete characterization of the fluctuations of credit ratings in large economies when adjustments follow a threshold rule. We also analyze the effects of downgrading cascades on aggregate losses of credit portfolios. We show that the loss distribution has a power-law tail if the interaction between different companies is strong enough.
Author: | Ulrich Horst |
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URN: | urn:nbn:de:0296-matheon-837 |
Referee: | Hans Föllmer |
Document Type: | Preprint, Research Center Matheon |
Language: | English |
Date of first Publication: | 2004/02/13 |
Release Date: | 2004/02/13 |
Institute: | Humboldt-Universität zu Berlin |
Technische Universität Berlin | |
Preprint Number: | 75 |