Default Clustering in Large Pools: Large Deviations

25 Pages Posted: 4 Nov 2013 Last revised: 24 Sep 2014

See all articles by Konstantinos Spiliopoulos

Konstantinos Spiliopoulos

Boston University

Richard Sowers

University of Illinois at Urbana-Champaign - Department of Mathematics

Date Written: July 31, 2014

Abstract

We study large deviations and rare default clustering events in a dynamic large heterogeneous pool of interconnected components.

Defaults come as Poisson events and the default intensities of the different components in the system interact through the empirical default rate and via systematic effects that are common to all components. We establish the large deviations principle for the empirical default rate for such an interacting particle system. The rate function is derived in an explicit form that is amenable to numerical computations and derivation of the most likely path to failure for the system itself. Numerical studies illustrate the theoretical findings. An understanding of the role of the preferred paths to large default rates and the most likely ways in which contagion and systematic risk combine to lead to large default rates would give useful insights into how to optimally safeguard against such events.

Suggested Citation

Spiliopoulos, Konstantinos and Sowers, Richard, Default Clustering in Large Pools: Large Deviations (July 31, 2014). Available at SSRN: https://ssrn.com/abstract=2349208 or http://dx.doi.org/10.2139/ssrn.2349208

Konstantinos Spiliopoulos (Contact Author)

Boston University ( email )

111 Cumminton Mall
Boston, MA 02215
United States

Richard Sowers

University of Illinois at Urbana-Champaign - Department of Mathematics ( email )

1409 W. Green St.
Urbana, IL 61801
United States

HOME PAGE: http://www.math.uiuc.edu/~r-sowers/

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