A Framework for Assessing the Systemic Risk of Major Financial Institutions

44 Pages Posted: 10 Aug 2009

See all articles by Xin Huang

Xin Huang

Board of Governors of the Federal Reserve System

Hao Zhou

Tsinghua University - PBC School of Finance

Haibin Zhu

Bank for International Settlements (BIS)

Multiple version iconThere are 3 versions of this paper

Date Written: April 2009

Abstract

In this paper we propose a framework for measuring and stress testing the systemic risk of a group of major financial institutions. The systemic risk is measured by the price of insurance against financial distress, 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. Our stress testing methodology, using an integrated micro-macro model, takes into account dynamic linkages between the health of major US banks and macro-financial conditions. Our results suggest that the theoretical insurance premium that would be charged to protect against losses that equal or exceed 15% of total liabilities of 12 major US financial firms stood at $110 billion in March 2008 and had a projected upper bound of $250 billion in July 2008.

Keywords: Systemic risk, stress testing, portfolio credit risk, credit default swap, high-frequency data

JEL Classification: G21, G28, G14, C13

Suggested Citation

Huang, Xin and Zhou, Hao and Zhu, Haibin, A Framework for Assessing the Systemic Risk of Major Financial Institutions (April 2009). BIS Working Paper No. 281, Available at SSRN: https://ssrn.com/abstract=1444430

Xin Huang

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Hao Zhou

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing, 100083
China
86-10-62790655 (Phone)

Haibin Zhu (Contact Author)

Bank for International Settlements (BIS) ( email )

Hong Kong
Hong Kong
852 2878 7145 (Phone)
852 2878 7123 (Fax)

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