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Econometric Measures of Connectedness and Systemic Risk in the Finance and Insurance SectorsMonica BillioCa Foscari University of Venice - Department of Economics Andrew W. LoMassachusetts Institute of Technology (MIT) - Sloan School of Management; Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL); National Bureau of Economic Research (NBER) Mila ShermanUniversity of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance & Operations Management Loriana PelizzonCa Foscari University of Venice - Department of Economics November 1, 2011 University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 21 MIT Sloan Research Paper No. 4774-10 AFA 2011 Denver Meetings Paper CAREFIN Research Paper No. 12/2010 Abstract: We propose several econometric measures of connectedness based on principal-components analysis and Granger-causality networks, and apply them to the monthly returns of hedge funds, banks, broker/dealers, and insurance companies. We find that all four sectors have become highly interrelated over the past decade, likely increasing the level of systemic risk in the finance and insurance industries through a complex and time-varying network of relationships. These measures can also identify and quantify financial crisis periods, and seem to contain predictive power in out-of-sample tests. Our results show an asymmetry in the degree of connectedness among the four sectors, with banks playing a much more important role in transmitting shocks than other financial institutions.
Number of Pages in PDF File: 57 Keywords: Systemic Risk, Financial Institutions, Liquidity, Financial Crises JEL Classification: G12, G29, C51 working papers seriesDate posted: November 23, 2011 ; Last revised: April 25, 2012Suggested CitationContact Information
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