Credit risk contagion and systemic risk on networks

Abstract

This paper proposes a model of the dynamics of credit contagion through non-performing loans on financial networks. Credit risk contagion is modeled in the context of the classical SIS (Susceptibles-Infected-Susceptibles) epidemic processes on networks but with a fundamental novelty. In fact, we assume the presence of two different classes of infected agents, and then we differentiate the dynamics of assets subject to idiosyncratic risk from those affected by systemic risk by adopting a SIIS (Susceptible-Infected1-Infected2-Susceptible) model. In the recent literature in this field, the effect of systemic credit risk on the performance of the financial network is a hot topic. We perform numerical simulations intended to explore the roles played by two different network structures on the long-term behavior of assets affected by systemic risk in order to analyze the effect of the topology of the underlying network structure on the spreading of systemic risk on the structure. Random graphs, i.e., the Erdös-Rényi model, are considered "benchmark" network structures while core-periphery structures are often indicated in the literature as idealized structures, although they are able to capture interesting, specific features of real-world financial networks. Moreover, as a matter of comparison, we also perform numerical experiments on small-world networks.