Risk Assessment based on the Analysis of the Impact of Contagion Flow

Journal of Banking & Finance, Volume 60, 2015, pp. 209-223.

42 Pages Posted: 15 May 2021

See all articles by Chanaka Edirisinghe

Chanaka Edirisinghe

Rensselaer Polytechnic Institute (RPI) - Lally School of Management & Technology

Aparna Gupta

Rensselaer Polytechnic Institute (RPI)

Wendy Roth

Georgia State University - J. Mack Robinson College of Business

Date Written: June 22, 2015

Abstract

This paper presents a new framework to model and calibrate the process of firm value evolution when an unanticipated exogenous event impacting one firm can contagiously affect other firms. The nature of propagation of such contagion is determined by the underlying connections between firms, which can adversely affect the tail risks of firm value, hence the securities issued by the firm. This paper combines the insights gained from the existing firm-value models and historical events into a structural model for flow of contagion among firms using a network-based approach. Rather than using stylized networks, we develop a data-driven approach for network construction where we define and calibrate several contagion variables to model the spread of contagion. This framework is applied for assessing firm-level risk under downside risk measures. Using actual data, our model illustrates how connections between firms can lead to heavy-tailed default distributions and default clustering observed in practice.

Keywords: Contagion, Bond Defaults, Factor Models, Firm-Level Risk Assessment

JEL Classification: G32, C63, D85

Suggested Citation

Edirisinghe, Chanaka and Gupta, Aparna and Roth, Wendy, Risk Assessment based on the Analysis of the Impact of Contagion Flow (June 22, 2015). Journal of Banking & Finance, Volume 60, 2015, pp. 209-223., Available at SSRN: https://ssrn.com/abstract=3845586 or http://dx.doi.org/10.2139/ssrn.3845586

Chanaka Edirisinghe (Contact Author)

Rensselaer Polytechnic Institute (RPI) - Lally School of Management & Technology ( email )

110 8th St
Troy, NY 12180
United States

Aparna Gupta

Rensselaer Polytechnic Institute (RPI) ( email )

Troy, NY 12180
United States

Wendy Roth

Georgia State University - J. Mack Robinson College of Business ( email )

P.O. Box 4050
Atlanta, GA 30303-3083
United States

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