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Econometric Measures of Connectedness and Systemic Risk in the Finance and Insurance Sectors

57 Pages Posted: 23 Nov 2011 Last revised: 25 Apr 2012

Monica Billio

Ca Foscari University of Venice - Dipartimento di Economia

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Mila Getmansky

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Ca Foscari University of Venice

Date Written: November 1, 2011

Abstract

We propose several econometric measures of connectedness based on principal-components analysis and Granger-causality networks, and apply them to the monthly returns of hedge funds, banks, broker/dealers, and insurance companies. We find that all four sectors have become highly interrelated over the past decade, likely increasing the level of systemic risk in the finance and insurance industries through a complex and time-varying network of relationships. These measures can also identify and quantify financial crisis periods, and seem to contain predictive power in out-of-sample tests. Our results show an asymmetry in the degree of connectedness among the four sectors, with banks playing a much more important role in transmitting shocks than other financial institutions.

Keywords: Systemic Risk, Financial Institutions, Liquidity, Financial Crises

JEL Classification: G12, G29, C51

Suggested Citation

Billio, Monica and Lo, Andrew W. and Getmansky, Mila and Pelizzon, Loriana, Econometric Measures of Connectedness and Systemic Risk in the Finance and Insurance Sectors (November 1, 2011). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 21; MIT Sloan Research Paper No. 4774-10; AFA 2011 Denver Meetings Paper; CAREFIN Research Paper No. 12/2010. Available at SSRN: https://ssrn.com/abstract=1963216 or http://dx.doi.org/10.2139/ssrn.1963216

Monica Billio (Contact Author)

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

HOME PAGE: http://www.unive.it/persone/billio

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

Mila Getmansky Sherman

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance ( email )

Amherst, MA 01003-4910
United States

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

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