Large Portfolio Losses: A dynamic contagion model
by Paolo Dai Pra of the University of Padova,
March 4, 2009
Abstract: Using particle system methodologies we study the propagation of financial distress in a network of firms facing credit risk. We investigate the phenomenon of a credit crisis and quantify the losses that a bank may suffer in a large credit portfolio. Applying a large deviation principle we compute the limiting distributions of the system and determine the time evolution of the credit quality indicators of the firms, deriving moreover the dynamics of a global financial health indicator. We finally describe a suitable version of the "Central Limit Theorem" useful to study large portfolio losses. Simulation results are provided as well as applications to portfolio loss distribution analysis.
Keywords: Credit contagion, credit crisis, interacting particle systems, Large Deviations, large portfolio losses, mean field interaction, non reversible Markov processes, phase transition.
Published in: Annals of Applied Probability, Vol. 19, No. 1, (February 2009), pp. 347-394.