The Equity Risk Posed by the Too-Big-To-Fail Banks: A Foster-Hart Estimation
Annals of Operations Research, 253 (1), 21–41, (2017).
26 Pages Posted: 26 Mar 2016 Last revised: 23 Aug 2023
Date Written: March 23, 2016
Abstract
The measurement of financial risk relies on two factors: determination of riskiness by use of an appropriate risk measure; and the distribution according to which returns are governed. Wrong estimates of either, severely compromise the accuracy of computed risk. We identify the too-big-to-fail banks with the set of “Global Systemically Important Banks” (G-SIBs) and analyze the equity risk of its equally weighted portfolio by means of the “Foster-Hart risk measure” — a bankruptcy-proof, reserve based measure of risk, extremely sensitive to tail events. We model banks’ stock returns as an ARMA-GARCH process with multivariate “Normal Tempered Stable” innovations, to capture the skewed and leptokurtotic nature of stock returns. Our union of the Foster-Hart risk modeling with fat-tailed statistical modeling bears fruit, as we are able to measure the equity risk posed by the G-SIBs more accurately than is possible with current techniques.
Keywords: Financial Risk, Normal Tempered Stable Distribution, Foster-Hart risk, Value-at-Risk (VaR), Average Value-at-Risk (AVaR)
JEL Classification: C13, C22, C58, C65, G32
Suggested Citation: Suggested Citation