Systemic Risk and Default Clustering for Large Financial Systems

Abstract

As it is known in the finance risk and macroeconomics literature, risk-sharing in large portfolios may increase the probability of creation of default clusters and of systemic risk. We review recent developments on mathematical and computational tools for the quantification of such phenomena. Limiting analysis such as law of large numbers and central limit theorems allow to approximate the distribution in large systems and study quantities such as the loss distribution in large portfolios. Large deviations analysis allow us to study the tail of the loss distribution and to identify pathways to default clustering. Sensitivity analysis allows to understand the most likely ways in which different effects, such as contagion and systematic risks, combine to lead to large default rates. Such results could give useful insights into how to optimally safeguard against such events.Comment: in Large Deviations and Asymptotic Methods in Finance, (Editors: P. Friz, J. Gatheral, A. Gulisashvili, A. Jacqier, J. Teichmann) , Springer Proceedings in Mathematics and Statistics, Vol. 110 2015