Dynamic Comovement among Banks, Systemic Risk, and the Macroeconomy

46 Pages Posted: 16 Dec 2016 Last revised: 16 Jun 2017

Pavel S. Kapinos

Federal Reserve Bank of Dallas--Financial Industry Studies

N. Kundan Kishor

Texas Tech University

Jun Ma

University of Alabama - Department of Economics, Finance and Legal Studies

Date Written: June 15, 2017

Abstract

This paper develops a new measure of comovement in the banking sector that takes into account the dynamic nature of interlinkages among different bank holding corporations at different stages of business cycles. For this purpose, we use a dynamic factor model with time-varying parameters and stochastic volatility that decomposes the panel data for the return on assets (ROA) and net chargeoffs (NCO) into a common component and an institution-specific idiosyncratic components. We find that the relative contribution of the common factor in explaining the variation in ROA and NCO peaked during the financial crisis, suggesting a significant increase in systemic stress in the banking sector. Using the least absolute shrinkage and selection operator (LASSO) approach, we show that the estimated common components and their stochastic volatilities from our approach perform well when compared to other widely used measures of systemic risk in explaining real economic activity. Furthermore, we find that these measures have better in-sample fit with real economic activity measures than the industry averages of ROA and NCO that are frequently used in the banking literature. Finally, we provide economic interpretation for the idiosyncratic components as banking balance sheet characteristics.

Keywords: business cycles, systemic risk, banks, dynamic factor model, return on assets, chargeoffs

JEL Classification: E32, G21

Suggested Citation

Kapinos, Pavel S. and Kishor, N. Kundan and Ma, Jun, Dynamic Comovement among Banks, Systemic Risk, and the Macroeconomy (June 15, 2017). Available at SSRN: https://ssrn.com/abstract=2886502 or http://dx.doi.org/10.2139/ssrn.2886502

Pavel S. Kapinos (Contact Author)

Federal Reserve Bank of Dallas--Financial Industry Studies ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

HOME PAGE: http://https://sites.google.com/site/pavelkapinos/

N. Kundan Kishor

Texas Tech University ( email )

2500 Broadway
Lubbock, TX 79409
United States

Jun Ma

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States

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