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

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 char...

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Bibliographic Details
Published in:arXiv.org 2022-12
Main Authors: Jarrow, Robert, Protter, Philip, Quintos, Alejandra
Format: Article
Language:English
Subjects:
Default
Failure
Impact analysis
Initial conditions
Probability
Online Access:Get full text
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Summary: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.
ISSN:2331-8422
DOI:10.48550/arxiv.2110.10936