development of a network strongmodelstrong for identification and.pdf

Development of a Network Model for Identification and Regulation of Systemic Risk in the Financial System Sponsored by CAS, CIA, SOA Joint Risk Management Section Prepared by Han Chen, Zhou Fang, Tony Ha, Shaun Wang, Xin Wang, Bruce Yang Risklighthouse, LLC October 2012 漏 2012 Casualty Actuarial Society, Canadian Institute of Actuaries, Society of Actuaries, All Rights Reserved The opinions expressed and conclusions reached by the authors are their own and do not represent any official position or opinion of the sponsoring organizations or their members. The sponsoring organizations make no representation or warranty to the accuracy of the information. DEVELOPMENT OF A NETWORK MODEL FOR IDENTIFICATION AND REGULATION OF SYSTEMIC RISK IN THE FINANCIAL SYSTEM Han Chen Zhou Fang Tony Ha Shaun Wang1 Xin Wang Bruce Yang Abstract Since the 2007 Financial Crisis, regulators have been very interested in modeling and measuring systemic risk in the financial system. In this study, a network approach is taken to characterize the systemic risk of two nontraditional insurance industries: the bond insurer industry and the CDS market. These industries were chosen since traditional insurance industries do not generate significant systemic risk. The network model for bond insurers demonstrates that after an exogenous shock (a fall in the housing market), bond insurers become insolvent not because of the cross holding of assets but because of the drastic increase in their liabilities. A second, structurally different network model of the CDS market shows how certain parameters of a network can affect the expected loss of the system relative to the initial loss caused by a default. This model also