Risk-Factor Portfolios and Financial Stability
46 Pages Posted: 11 Nov 2009 Last revised: 12 Mar 2010
Date Written: February 2, 2010
Abstract
By utilizing the extreme dependence structure and the conditional probability of joint failure (CPJF) among risk factors, this paper characterizes a risk-stability index (RSI) that quantifies (i) common distress of risk factors, (ii) distress between specific risk factors, and (iii) distress to a portfolio related to a specific risk factor. The results show that financial stability is a continuum; that U.S. banks tend to cause the most stress to the global financial system (as defined herein); and that Asian banks show the most persistence of distress. Further, the panel VAR indicates that "leaning against the wind" reduces the (potential) instability of a financial system.
Keywords: Conditional probability of joint failure, contagion, dependence structure, distress, multivariate extreme value theory, panel VAR, persistence
JEL Classification: C10, E44, F15, F36, F37
Suggested Citation: Suggested Citation
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