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Measuring Flight-to-Quality with Granger-Causality Tail Risk Networks

39 Pages Posted: 10 Mar 2015  

Fulvio Corsi

Ca' Foscari University of Venice; City University London

Fabrizio Lillo

Scuola Normale Superiore

Davide Pirino

Dipartimento di Economia e Finanza, Università degli Studi di Roma "Tor Vergata"

Date Written: March 10, 2015

Abstract

We introduce an econometric method to detect and analyze events of flight-to-quality by financial institutions. Specifically, using the recently proposed test for the detection of Granger causality in risk (Hong et al. 2009), we construct a bipartite network of systemically important banks and sovereign bonds, where the presence of a link between two nodes indicates the existence of a tail causal relation. This means that tail events in the equity variation of a bank helps in forecasting a tail event in the price variation of a bond. Inspired by a simple theoretical model of flight-to-quality, we interpret links of the bipartite networks as distressed trading of banks directed toward the sovereign debt market and we use them for defining indicators of flight-to-quality episodes. Based on the quality of the involved bonds, we distinguish different patterns of flight-to-quality in the 2006-2014 period. In particular, we document that, during the recent Eurozone crisis, banks with a considerable systemic importance have significantly impacted the sovereign debt market chasing the top-quality government bonds. Finally, an out of sample analysis shows that connectedness and centrality network metrics have a significant cross-sectional forecasting power of bond quality measures.

Keywords: flight-to-quality, sovereign debt crisis, systemic risk, Granger causality, illiquidity, fire sales, bi-partite networks

JEL Classification: G00, G01, G21, H63, C12

Suggested Citation

Corsi, Fulvio and Lillo, Fabrizio and Pirino, Davide, Measuring Flight-to-Quality with Granger-Causality Tail Risk Networks (March 10, 2015). Available at SSRN: https://ssrn.com/abstract=2576078 or http://dx.doi.org/10.2139/ssrn.2576078

Fulvio Corsi

Ca' Foscari University of Venice ( email )

Cannaregio 873
Venice, Non-US 30121
Italy

City University London ( email )

Northampton Square
London, EC1V OHB
United Kingdom

Fabrizio Lillo

Scuola Normale Superiore ( email )

Piazza dei Cavalieri, 7
Pisa, 56126
Italy

Davide Pirino (Contact Author)

Dipartimento di Economia e Finanza, Università degli Studi di Roma "Tor Vergata" ( email )

Via Columbia 2
Rome, Lazio 00133
Italy

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