Systemic Risk and Default Cascades in Global Equity Markets: Extending the Gai-Kapadia Framework with Stochastic Simulations and Network Analysis (2504.01969v2)

Abstract: This study pioneers the application of the Gai-Kapadia framework, originally developed for interbank contagion, to global equity markets. It offers a novel approach to assess systemic risk and default cascades. Using a 20-asset network (13 Brazilian and 7 developed market assets) from 2015 to 2025, we construct exposure-based networks from price co-movements, applying thresholds theta = 0.3 and theta = 0.5 to capture significant interconnections. Cascade dynamics are evaluated through Monte Carlo simulations (n = 1000) with shocks ranging from 10 to 50 percent, complemented by deterministic propagation analysis. Results show that high clustering among Brazilian assets (Ci approx 1.0) leads to localized contagion, with an average of 2.0 failed assets per simulation. In contrast, developed markets with lower connectivity (Ci approx 0.2 to 0.4) show resilience, with zero failures beyond Brazil in all scenarios. Network visualizations highlight structural vulnerabilities: deterministic cascades reach up to 20 assets at theta = 0.3, but only 3 to 4 at theta = 0.5. Risk measures such as VaR and CVaR at 95 percent confidence confirm higher tail risks in emerging markets. This adaptation of the Gai-Kapadia model provides a robust framework for systemic risk assessment. The findings suggest that regulators should target high-clustering nodes in emerging markets, while portfolio managers may benefit from the resilience of developed markets to enhance diversification.