Towards a Financial Statement Based Approach to Modeling Systemic Risk in Insurance and Banking

70 Pages Posted: 31 Jul 2017

See all articles by Garud Iyengar

Garud Iyengar

Columbia University - Department of Industrial Engineering and Operations Research (IEOR)

Yu Luo

Columbia University - Department of Chemical Engineering

Shivaram Rajgopal

Columbia Business School

Venkat Venkatasubramanian

Department of Chemical Engineering

Zhizun Zhang

Columbia University, Department of Chemical Engineering, Students

Date Written: July 25, 2017

Abstract

One of the important limitations of the SRISK measure of systemic risk, proposed by Brownlees and Engle and Acharya, Engle and Richardson, is its reliance on stock market data without much validation against the institutions’ fundamentals based on its financial statements. We propose a financial statement based approach to estimating the vulnerability of an institution to a systemic event (labeled CRISK). We illustrate our approach for three business models: a life insurer (Prudential), a property and casualty insurer (Chubb) and an investment bank (J.P. Morgan Chase). We also validate CRISK using AIG’s capital shortfall during the 2008 financial crisis. Our approach reveals that SRISK is likely to (i) overstate (misstate) capital requirements for life insurers (P&C insurers); and (ii) to overstate capital requirements for banks heavily reliant on FDIC insured deposits. We recommend using the market based SRISK measure as a first cut filter to identify systemically important institutions. The analyst can refine the list and validate the expected capital shortfall number using CRISK or a detailed financial statement analysis of the kind we advocate in this paper.

Keywords: insurance, banking, SRISK, financial statements, systemic risk, fundamental analysis

JEL Classification: c58, g21, g22, m4

Suggested Citation

Iyengar, Garud and Luo, Yu and Rajgopal, Shivaram and Venkatasubramanian, Venkat and Zhang, Zhizun, Towards a Financial Statement Based Approach to Modeling Systemic Risk in Insurance and Banking (July 25, 2017). Columbia Business School Research Paper No. 17-77. Available at SSRN: https://ssrn.com/abstract=3008946 or http://dx.doi.org/10.2139/ssrn.3008946

Garud Iyengar

Columbia University - Department of Industrial Engineering and Operations Research (IEOR) ( email )

331 S.W. Mudd Building
500 West 120th Street
New York, NY 10027
United States
+1 212-854-4594 (Phone)
+1 212-854-8103 (Fax)

Yu Luo

Columbia University - Department of Chemical Engineering ( email )

500 W. 120th St.
New York, NY 10027
United States

HOME PAGE: http://https://l16cn.github.io

Shivaram Rajgopal (Contact Author)

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Venkat Venkatasubramanian

Department of Chemical Engineering ( email )

New York, NY
United States

HOME PAGE: http://cheme.columbia.edu/venkat-venkatasubramanian

Zhizun Zhang

Columbia University, Department of Chemical Engineering, Students ( email )

New York, NY
United States

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