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20 - Counterparty Contagion in Context: Contributions to Systemic Risk

from PART VI - COUNTERPARTY RISK AND SYSTEMIC RISK

Published online by Cambridge University Press:  05 June 2013

By
Jeremy Staum
Edited by
Jean-Pierre Fouque  and
Joseph A. Langsam
Jeremy Staum
Affiliation:
Northwestern University
Jean-Pierre Fouque
Affiliation:
University of California, Santa Barbara
Joseph A. Langsam
Affiliation:
University of Maryland, College Park
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Summary

Abstract This chapter surveys models of counterparty contagion and their application in systemic risk management, emphasizing the network of counterparty relationships. It addresses how counterparty contagion contributes to systemic risk in combination with other sources of risk, and how models of counterparty contagion can be used to attribute systemic risk to participants in the financial system. The article discusses challenges and possible progress to be made in modeling the counterparty network and the dynamics of the financial system.

Introduction

This survey attempts to present a unified view of a mushrooming literature on counterparty contagion and its significance for systemic risk. This literature is so broad as to include mathematical treatments of random graphs, interacting particle systems, and Markov processes, but also financial theorizing about such topics as balance sheet constraints and haircuts in collateralized lending, and also empirical studies of data provided by banking regulators. Contagion is distinguished from correlation between firms that does not feature a causal link; counterparty contagion as mediated by various kinds of bilateral deals is distinguished from other forms of contagion that are intermediated by markets (§20.2).

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Chapter
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Handbook on Systemic Risk , pp. 512 - 544
Publisher: Cambridge University Press
Print publication year: 2013

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