Mean-field equilibrium price formation under single-default risk
Abstract
We study equilibrium price formation in an incomplete financial market with a large population of agents, where stock prices are subject to a single-default event. Agents are assumed to be heterogeneous in their risk aversion and terminal liabilities, and maximize exponential utility of terminal net wealth. We first characterize each agent's optimal strategy by a quadratic-growth backward stochastic differential equation (BSDE) driven by Brownian motions and a compensated default martingale. We then formulate the market-clearing condition in terms of aggregate optimal demand and derive a mean-field quadratic-growth BSDE for the equilibrium risk premium. The resulting characterization quantifies how default intensity, jump size, and agent heterogeneity jointly shape the default-risk component of equilibrium security risk premia. Under a Markovian factor model, we establish short-time solvability of the mean-field BSDE through a fixed-point argument based on estimates for a coupled semilinear PDE system. Finally, we show that the risk premium characterized by the mean-field BSDE asymptotically clears the market as the population size tends to infinity.