Financial Systemic Risk

N Chen

Financial institutions knit a complex network. They interconnect with each other directly through active borrowing-and-lending activities and holding significant amount of marketable securities against each other. In normal times, this network helps the institutions diversify their idiosyncratic risks to achieve an efficient allocation of economic resources. However, under crisis conditions, this network can be easily turned into a conduit that propagates failures at one or several institutions to the entire system. Further complicating the matter is a second layer of interconnectedness of the institutions, indirectly via the market. The asset fire sale by a distressed firm will create a significant negative externality for the rest of the system. As the recent financial crisis reveals, these two, direct and indirect but mutually enhancing, channels play an important role in the development of systemic risk. The objectives of my research aims to develop mathematical tools to modeling and analyzing systemic risk, in particular studying how defaults spread through the entire financial system.