Causal analysis of extreme risk in a network of industry portfolios

Abstract

We present a methodology for causal risk analysis in a network. Causal dependence is formulated by a max-linear structural equation model, which expresses each node variable as a max-linear function of its parental node variables in a directed acyclic graph and some exogenous innovation. We determine directed~paths~responsible~for extreme risk propagation in the network. We give algorithms for structure learning and parameter estimation and apply them to a network of financial data.

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