A Simple Indicator of Systemic Risk

43 Pages Posted: 15 Mar 2010

See all articles by Dilip K. Patro

Dilip K. Patro

OCC

Min Qi

Office of the Comptroller of the Currency - Credit Risk Analysis Division

Xian Sun

Johns Hopkins University - Carey Business School

Date Written: March 11, 2010

Abstract

We examine the relevance and effectiveness of stock return correlations among financial institutions as an indicator of systemic risk. By analyzing the trends and fluctuations of daily stock return correlations and default correlations among the 22 largest bank holding companies and investment banks from 1988 to 2008, we find that daily stock return correlation is a simple, robust, forward-looking, and timely systemic risk indicator. There is an increasing trend in stock return correlation among banks, whereas there is no obvious correlation trend among non-banks. Correlation spikes tend to predict or coincide with significant economic or market events, especially during the 2007-2008 financial crisis. Furthermore, stock return correlations can offer a perspective on the level of systemic risk in the financial sector that is not already captured by default correlations. Stock return correlations are not subject to data limitations or model specification errors that other potential systemic risk measures may face. Therefore, we recommend that regulators and businesses monitor daily stock return correlations among financial institutions to track the level of systemic risk.

Suggested Citation

Patro, Dilip K. and Qi, Min and Sun, Xian, A Simple Indicator of Systemic Risk (March 11, 2010). Available at SSRN: https://ssrn.com/abstract=1569805 or http://dx.doi.org/10.2139/ssrn.1569805

Dilip K. Patro

OCC ( email )

400 7th Street SW
Washington, DC 20219
United States
202-649-5548 (Phone)

Min Qi

Office of the Comptroller of the Currency - Credit Risk Analysis Division ( email )

250 E Street, SW
Washington, DC 20219
United States

Xian Sun (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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