Aggregate and Firm-Level Measures of Systemic Risk from a Structural Model of Default

Posted: 20 Dec 2015

See all articles by Alexander Reyngold

Alexander Reyngold

Independent

Ksenia Shnyra

Independent

Roger Stein

Sloan School of Management, MIT

Date Written: March 15, 2015

Abstract

The breadth and dynamics of the recent financial crisis have led to efforts to develop forward-looking tools to monitor systemic risk. In this article, the authors propose a new measure that is an extension of the absorption ratio (AR) introduced in 2010 by Kritzman, Li, Page, and Rigobon. Using principal component analysis (as in the original AR methodology) in conjunction with a structural model of default, the authors develop a measure of systemic risk that may be calculated using only publicly available data. They call the new measure the credit absorption ratio (CAR) and find that increases in the CAR preceded periods of financial distress during the recent crisis. The CAR may be interpreted economically: it highlights states of the financial system during which the credit fundamentals of institutions and markets exhibit heightened coupling and higher potential for cascading distress. The authors also demonstrate that a byproduct of CAR analysis provides a measure of the degree to which specific financial institutions are exposed to systemic risk factors at any point in time. They find that a number of the institutions that exhibited, under the CAR measure, high potential exposure during the lead-up to the recent crisis subsequently experienced higher levels of distress or required external assistance.

Keywords: systemic risk, structural model of default, credit models

Suggested Citation

Reyngold, Alexander and Shnyra, Ksenia and Stein, Roger, Aggregate and Firm-Level Measures of Systemic Risk from a Structural Model of Default (March 15, 2015). Journal of Alternative Investments, Vol. 17, No. 4, 2015. Available at SSRN: https://ssrn.com/abstract=2705830

Alexander Reyngold

Independent ( email )

No Address Available

Ksenia Shnyra

Independent ( email )

No Address Available

Roger Stein (Contact Author)

Sloan School of Management, MIT ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://www.rogermstein.com

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