A0801
Title: Default risk propagation in a multilayer system
Authors: Zhiwei Tong - The University of Iowa (United States) [presenting]
Abstract: Default risk propagation is investigated within a multilayer system with dependence between different layers of the financial system (interdependence) as well as within each layer (intradependence). In times of financial distress, losses spread across sectors of the economy, resulting in the impairment of the entire financial system and leading to systemically relevant consequences. Strong propagation of default risk is discovered across different layers. To show this insight, simplicity for a two-layer network of intermediaries is considered in the low-default environment in which each intermediary has a default probability p. Given a cluster of defaults, namely, a significantly large number of defaults, in one layer, the conditional probability of a cluster of defaults is investigated in the other layer. Under various general conditions on the intradependence and interdependence structures, it is obtained that this conditional probability is asymptotic to $c*p$ as p approaches 0 for some positive constant c, where c represents the propagation effect across the two layers.
