Assessing the Systemic Risk of a Heterogeneous Portfolio of Banks during the Recent Financial Crisis

45 Pages Posted: 23 Aug 2009 Last revised: 29 Oct 2011

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)

Date Written: January 26, 2010

Abstract

This paper extends the approach of measuring and stress-testing the systemic risk of a banking sector in Huang, Zhou, and Zhu (2009) to identifying various sources of financial instability and to allocating systemic risk to individual financial institutions. The systemic risk measure, defined as the insurance cost to protect against distressed losses in a banking system, is a summary indicator of market perceived risk that reflects expected default risk of individual banks, risk premia as well as correlated defaults. An application of our methodology to a portfolio of twenty-two major banks in Asia and the Pacific illustrates the dynamics of the spillover effects of the global financial crisis to the region. The increase in the perceived systemic risk, particularly after the failure of Lehman Brothers, was mainly driven by the heightened risk aversion and the squeezed liquidity. Further analysis, which is based on our proposed approach to quantifying the marginal contribution of individual banks to the systemic risk, suggests that “too-big-to-fail” is a valid concern from a macroprudential perspective of bank regulation.

Keywords: Systemic risk, Macroprudential regulation, Portfolio distress loss, Credit default swap, Dynamic conditional correlation

JEL Classification: G21, G28, C13

Suggested Citation

Huang, Xin and Zhou, Hao and Zhu, Haibin, Assessing the Systemic Risk of a Heterogeneous Portfolio of Banks during the Recent Financial Crisis (January 26, 2010). 22nd Australasian Finance and Banking Conference 2009; Finlawmetrics 2010 Conference Paper. Available at SSRN: https://ssrn.com/abstract=1459946 or http://dx.doi.org/10.2139/ssrn.1459946

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, Chengdu 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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