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Probability and Computational Finance Seminar
Agostino Capponi
Purdue University
Title: Default and Systemic Risk in Equilibrium

Abstract: We develop a finite horizon continuous time market model, where risk averse investors maximize utility from terminal wealth by dynamically investing in a risk-free money market account, a stock, and a defaultable bond. The prices of the securities depend on common stochastic economic fundamentals, and are determined in equilibrium.

Using techniques from utility maximization and duality theory, we analyze the relation between the stock and the defaultable security. We find that they exhibit an endogenous interaction depending on equilibrium behavior of investors, risk preferences, and cyclicality properties of the default intensity. We show that the equilibrium price of the stock experiences a jump at default, despite that the default event has no causal impact on the underlying economic fundamentals. The direction of the jump is characterized in terms of a relation involving investor preferences, and monotonicity properties of the default intensity.

Date: Monday, November 19, 2012
Time: 5:00 pm
Location: Wean Hall 6423
Submitted by:  Kasper Larsen