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Tracking Variation in Systemic Risk at US Banks During 1974-2013

55 Pages Posted: 1 Apr 2012 Last revised: 12 Aug 2015

Armen Hovakimian

Baruch College - Zicklin School of Business

Edward J. Kane

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Luc Laeven

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: August 10, 2015

Abstract

This paper proposes a theoretically based and easy-to-implement way to measure the systemic risk of financial institutions using publicly available accounting and stock market data. The measure models the credit enhancement taxpayers provide to individual banks in the Merton tradition (1974) as a combination put option for the deep tail of bank losses and a knock-in stop-loss call on bank assets. This model expresses the value of taxpayer loss exposure from a string of defaults as the value of this combination option written on the portfolio of industry assets. The exercise price of the call is the face value of the debt of the entire sector. We conceive of an individual bank’s systemic risk as its contribution to the value of this sector-wide option on the financial safety net. To the extent that authorities are slow to see bank losses or reluctant to exercise the call, the government itself becomes a secondary source of systemic risk. We apply our model to quarterly data over the period 1974-2013. The model indicates that systemic risk reached unprecedented highs during the financial crisis years 2008-2009, and that bank size, leverage, and asset risk are key drivers of systemic risk.

Keywords: systemic risk, safety net, financial institutions, financial crises, bailout costs

JEL Classification: G21, K23, G28

Suggested Citation

Hovakimian, Armen and Kane, Edward J. and Laeven, Luc, Tracking Variation in Systemic Risk at US Banks During 1974-2013 (August 10, 2015). Available at SSRN: https://ssrn.com/abstract=2031798 or http://dx.doi.org/10.2139/ssrn.2031798

Armen Hovakimian

Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-225
New York, NY 10010
United States
646-312-3490 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/ahovakimian/

Edward J. Kane (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
520-299-5066 (Phone)
617-552-0431 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Luc A. Laeven

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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