Option Implied Measures of Systemic Risk in the US Financial Sector: Operator and Quadrature Measures of Extreme Events

43 Pages Posted: 15 Dec 2016 Last revised: 2 May 2017

See all articles by Yang Zhang

Yang Zhang

Northwestern University; Durham Business School

Valentina Lagasio

Sapienza University

Marina Brogi

University of Rome I - Dipartimento Banche Assicurazioni Mercati

Julian M. Williams

Durham Business School

Date Written: May 2, 2017

Abstract

Eigenfunction and quadrature methods have been extensively used in asset pricing as a forecasting tool. In contrast, their application to systemic risk has been limited. With the advent of high frequency options panels we document a battery of measures that can be used to measure and forecast systemic risk, these include computationally intensive dependency measures such as cubic and quartic average implied correlations. We then demonstrate, using the cross section of all US banks in Compustat, that our forward-looking, option-market based measures, are effective used in augmenting the forecasting component of a standard bank stress-testing model.

Keywords: Systemic Risk, Correlation Risk, CLASS Model, Contingent Pricing

JEL Classification: C23, C53, G17, G20, G13

Suggested Citation

Zhang, Yang and Lagasio, Valentina and Brogi, Marina and Williams, Julian M., Option Implied Measures of Systemic Risk in the US Financial Sector: Operator and Quadrature Measures of Extreme Events (May 2, 2017). Available at SSRN: https://ssrn.com/abstract=2884904 or http://dx.doi.org/10.2139/ssrn.2884904

Yang Zhang (Contact Author)

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

Valentina Lagasio

Sapienza University ( email )

Via del Castro Laurenziano, 9
Rome, 00185
Italy

Marina Brogi

University of Rome I - Dipartimento Banche Assicurazioni Mercati ( email )

Rome
Italy

Julian M. Williams

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

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