Default Contagion and Systemic Risk with Cross-Ownership of Equities, Debts, and Financial Derivatives
25 Pages Posted: 1 Feb 2017 Last revised: 6 Mar 2020
Date Written: March 5, 2020
We consider a situation in which general financial products such as options, CDS, and other derivatives, are traded to investigate the effect of cross-ownerships on market stability. We prove the existence and uniqueness of a clearing payment vector under the assumption of the fictitious default algorithm with financial covenants, which reflects technical defaults often observed in actual financial markets. Unlike other related studies, the sufficient condition for the existence involves not only the cross-ownership structure but also the risk exposures associated with the securities cross-held. Some numerical results are presented to show that stronger connectedness via CDSs leads to a more unstable market and higher systemic risk, especially with higher default costs.
Keywords: cross-ownership, default cost, clearing payment, credit default swap, default contagion, systemic risk
JEL Classification: G13, G32, G33, L14
Suggested Citation: Suggested Citation