46 Pages Posted: 22 Mar 2010 Last revised: 9 Aug 2010
Date Written: May 2010
We present an economic model of systemic risk and show that each financial institution's contribution to systemic risk can be measured as its systemic expected shortfall (SES), i.e., its propensity to be undercapitalized when the system as a whole is undercapitalized. SES increases in the institution's leverage and its marginal expected shortfall (MES), i.e., its losses in the tail of the system's loss distribution. Institutions internalize their externality if they are "taxed" based on their SES. We demonstrate empirically the ability of components of SES to predict emerging systemic risk during the financial crisis of 2007-2009, in particular, (i) the outcome of stress tests performed by regulators; (ii) the decline in equity valuations of large financial firms in the crisis; and, (iii) the widening of their credit default swap spreads.
Keywords: systemic risk, bailout, financial regulation, value at risk
Suggested Citation: Suggested Citation
Acharya, Viral V. and Pedersen, Lasse Heje and Philippon, Thomas and Richardson, Matthew P., Measuring Systemic Risk (May 2010). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1573171 or http://dx.doi.org/10.2139/ssrn.1573171