A System-Wide Approach to Measure Connectivity in the Financial Sector

72 Pages Posted: 11 Aug 2016 Last revised: 17 Jul 2020

See all articles by Sumanta Basu

Sumanta Basu

Cornell University

Sreyoshi Das

University of Michigan at Ann Arbor - Department of Economics

George Michailidis

University of Michigan at Ann Arbor

Amiyatosh Purnanandam

University of Michigan, Stephen M. Ross School of Business

Date Written: November 15, 2019

Abstract

We introduce and estimate a model that leverages a system-wide approach to identify systemically important financial institutions. Our Debiased Lasso penalized Vector Auto-regressive (DLVAR) framework, based on formal Granger Causality tests for large multivariate time series, explicitly allows for the possibility of connectivity amongst all institutions under consideration: this is in sharp contrast with most extant measures of systemic risk that, either explicitly or implicitly, estimate such connections using pairwise relationships between institutions. In addition, our method corrects for shrinkage bias and provides formal uncertainty quantification of estimated network edges, hence overcoming two key limitations of recently proposed lasso and sparsity regularized VAR models. Using simulations we show that our approach can provide considerable improvement over extant measures. We estimate our model for large financial institutions in the U.S. and show its usefulness in detecting systemically stressful periods and institutions.

Keywords: Systemic Risk, Financial Networks, Lasso, Vector Autoregression

JEL Classification: C58, G01, G29

Suggested Citation

Basu, Sumanta and Das, Sreyoshi and Michailidis, George and Purnanandam, Amiyatosh, A System-Wide Approach to Measure Connectivity in the Financial Sector (November 15, 2019). Available at SSRN: https://ssrn.com/abstract=2816137 or http://dx.doi.org/10.2139/ssrn.2816137

Sumanta Basu (Contact Author)

Cornell University ( email )

Ithaca, NY 14853
United States

Sreyoshi Das

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

George Michailidis

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

Amiyatosh Purnanandam

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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