Particle systems with singular interaction through hitting times: application in systemic risk modeling

DOI10.1214/18-AAP1403MaRDI QIDQ670735zbMATH OpenOpenAlexWikidataFDO

Authors Sergey Nadtochiy, Mykhaylo Shkolnikov

Publication date 20 March 2019

Published in The Annals of Applied Probability (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1705.00691, https://projecteuclid.org/euclid.aoap/1544000426

zbMATH Keywords

banking systemsblow-ups in parabolic partial differential equationsdefault cascadesinteracting particle systemslarge system limitsloss of continuitymean-field modelsnoncore exposuresnonlinear Cauchy-Dirichlet problemsregularity estimatesself-excitationsingular interactionsystemic crisessystemic risk

Mathematics Subject Classification ID

Blow-up in context of PDEs (35B44) Smoothness and regularity of solutions to PDEs (35B65) Initial-boundary value problems for second-order parabolic equations (35K20) PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Interacting particle systems in time-dependent statistical mechanics (82C22) Financial applications of other theories (91G80)

Abstract: We propose an interacting particle system to model the evolution of a system of banks with mutual exposures. In this model, a bank defaults when its normalized asset value hits a lower threshold, and its default causes instantaneous losses to other banks, possibly triggering a cascade of defaults. The strength of this interaction is determined by the level of the so-called non-core exposure. We show that, when the size of the system becomes large, the cumulative loss process of a bank resulting from the defaults of other banks exhibits discontinuities. These discontinuities are naturally interpreted as systemic events, and we characterize them explicitly in terms of the level of non-core exposure and the fraction of banks that are "about to default". The main mathematical challenges of our work stem from the very singular nature of the interaction between the particles, which is inherited by the limiting system. A similar particle system is analyzed in [DIRT15a] and [DIRT15b], and we build on and extend their results. In particular, we characterize the large-population limit of the system and analyze the jump times, the regularity between jumps, and the local uniqueness of the limiting process.

Review text

By using the mean-field approach and a structural mechanism of default contagion, the authors model the dynamics of an interconnected systems of banks. They estimate the proximity of a systemic failure (the occurrence of a significantly large default cascade) which would allow a regulator to intervene ahead of time. The times of such cascades are captured by the discontinuity points of the cumulative loss process in a limiting system. An explicit connection between the occurrence of systemic events and the internal characteristics of the banking system is also presented. The mathematical model considered by the authors is based on a system of Brownian particles with singular interaction through hitting times. The regularity of the limiting process and its local uniqueness are finally established in this paper.

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Cited in

(44)

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