Systemic Risk Diagnostics: Coincident Indicators and Early Warning Signals
38 Pages Posted: 19 Apr 2011
Date Written: April 4, 2011
We propose a novel framework to assess financial system risk. Using a dynamic factor framework based on state-space methods, we construct coincident measures (‘thermometers’) and a forward looking indicator for the likelihood of simultaneous failure of a large number of financial intermediaries. The indicators are based on latent macro-financial and credit risk components for a large data set comprising the U.S., the EU-27 area, and the respective rest of the world. Credit risk conditions can significantly and persistently de-couple from macro-financial fundamentals. Such decoupling can serve as an early warning signal for macro-prudential policy.
Keywords: financial crisis, systemic risk, credit portfolio models, frailty-correlated defaults, state space methods
JEL Classification: G21, C33
Suggested Citation: Suggested Citation