A Framework for Assessing the Systemic Risk of Major Financial Institutions
Posted: 22 Mar 2009 Last revised: 17 Jan 2016
Date Written: October 1, 2008
In this paper we propose a framework for measuring and stress testing the systemic risk for a group of major commercial banks and investment banks. The systemic risk is measured by the price of insurance against financial distresses, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations. Importantly, using realized correlations estimated from high-frequency equity return data can significantly improve the accuracy of forecasted correlations. In addition, our stress testing methodology, as an integrated micro-macro model, takes into account dynamic linkages between the health of major US banks and the macro-financial condition.
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Keywords: Stress testing, systemic risk, insurance premium, default probability, credit default swap spread, high-frequency data, asset return correlation
JEL Classification: G21, G28, G14, C13
Suggested Citation: Suggested Citation