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Network Effects and Default Clustering for Large Portfolios

Konstantinos Spiliopoulos and Jia Yang

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Abstract: We consider a large collection of dynamically interacting components defined on a weighted directed graph determining the impact of default of one component to another one. We prove a law of large numbers for the empirical measure capturing the evolution of the different components in the pool and from this we extract important information for quantities such as the loss rate in the overall pool as well as the mean impact on a given component from system wide defaults. A singular value decomposition of the adjacency matrix of the graph allows to coarse-grain the system by focusing on the highest eigenvalues which also correspond to the components with the highest contagion impact on the pool. Numerical simulations demonstrate the theoretical findings.

Date: 2018-12
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Handle: RePEc:arx:papers:1812.07645