Coupled diffusions and systemic risk

Mathematical Finance/Financial Engineering Seminar
Wednesday, October 31, 2012 - 3:05pm for 1 hour (actually 50 minutes)
Skiles 006
J.-P. Fouque – Department of Statistics and Applied Probability, University of California Santa Barbara,
Christian Houdré

Please Note: Hosted by Christian Houdre and Liang Peng

We present a simple model of diffusions coupled through their drifts in a way that each component mean-reverts to the mean of the ensemble. In particular, we are interested in the number of components reaching a "default" level in a given time. This coupling creates stability of the system in the sense that there is a large probability of "nearly no default". However, we show that this "swarming" behavior also creates a small probability that a large number of components default corresponding to a "systemic risk event". The goal is to illustrate systemic risk with a toy model of lending and borrowing banks, using mean-field limit and large deviation estimates for a simple linear model. In the last part of the talk we will show some recent work with Rene Carmona on a "Mean Field Game" version of the previous model and the effects of the game on stability and systemic risk.