Modeling Financial Contagion Using Mutually Exciting Jump Processes / Yacine Aït-Sahalia, Julio Cacho-Diaz, Roger J.A. Laeven.

Format:

Book

Author/Creator:

Aït-Sahalia, Yacine.

Contributor:

National Bureau of Economic Research.

Cacho-Diaz, Julio.

Laeven, Roger J.A.

Series:

Working Paper Series (National Bureau of Economic Research) no. w15850.

NBER working paper series no. w15850

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2010.

Summary:

Adverse shocks to stock markets propagate across the world, with a jump in one region of the world seemingly causing an increase in the likelihood of a different jump in another region of the world. To capture this effect mathematically, we introduce a model for asset return dynamics with a drift component, a volatility component and mutually exciting jumps known as Hawkes processes. In the model, a jump in one region of the world or one segment of the market increases the intensity of jumps occurring both in the same region (self-excitation) as well as in other regions (cross-excitation). The model generates the type of jump clustering that is observed empirically. Jump intensities then mean-revert until the next jump. We develop and implement an estimation procedure for this model. Our estimates provide evidence for self-excitation both in the US market as well as in other world markets. Furthermore, we find that US jumps tend to get reflected quickly in most other markets, while statistical evidence for the reverse transmission is much less pronounced. Implications of the model for measuring market stress, risk management and optimal portfolio choise are also investigated.

Notes:

Print version record

March 2010.