Computing the Probability of a Financial Market Failure: A New Measure of Systemic Risk

Robert Jarrow (), Philip Protter and Alejandra Quintos

Papers from arXiv.org

Abstract: This paper characterizes the probability of a market failure defined as the default of two or more globally systemically important banks (G-SIBs) in a small interval of time. The default probabilities of the G-SIBs are correlated through the possible existence of a market-wide stress event. The characterization employs a multivariate Cox process across the G-SIBs, which allows us to relate our work to the existing literature on intensity-based models. Various theorems related to market failure probabilities are derived, including the probability of a market failure due to two banks defaulting over the next infinitesimal interval, the probability of a catastrophic market failure, the impact of increasing the number of G-SIBs in an economy, and the impact of changing the initial conditions of the economy's state variables. We also show that if there are too many G-SIBs, a market failure is inevitable, i.e., the probability of a market failure tends to 1.

Date: 2021-10, Revised 2022-12
New Economics Papers: this item is included in nep-ban and nep-rmg
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Computing the probability of a financial market failure: a new measure of systemic risk (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2110.10936

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