Tackling the Volatility Paradox: Spillover Persistence and Systemic Risk

Abstract

This paper introduces Spillover Persistence as a novel characteristic of systemic risk, which reflects the dynamics of losses in the financial system. Declines in Spillover Persistence capture buildups of fragility before systemic risk materializes, both during the run-up phase of banking crises and asset price bubbles. Consistent with the volatility paradox in macro-finance models, loose financial constraints connect declines in Spillover Persistence to fragility. When systemic risk materializes and amplification effects arise, Spillover Persistence increases. Thus, it disentangles fragility from amplification effects, which is useful to implement countercyclical regulation and extends existing systemic risk measures.

Keywords: Systemic Risk, Fragility, Financial Crises, Asset Price Bubbles, Fire Sales

JEL Classification: E44, G01, G12, G20, G32