Banking Crisis and Cyclic Shocks: A Perspective on Volatility Clustering

Abstract

Typical systemic risk measurement barely captures the dynamic risk characteristics of the entire banking system. Experience from past financial crises shows, major indicators in financial markets have clustered volatility during periods of economic downturns. This study focuses on the overall profile of the commercial banking sector. The Ratio of Adjusted Weighted Estimated Loss is introduced as an indicator of banking crisis to analyze volatility clustering in a system-wide perspective. The results show that crises indicator volatility tends to cluster together when distress signals begin to appear in the market. A leverage effect is also presented in the results when applying the EGARCH model. Analysis of the effect of cyclic shocks discusses the process of risk transfer from exogenous shocks to endogenous contagion. The results have implications for a better understanding of the relationship between business cycle and banking crises.

Keywords: EGARCH, Volatility Clustering, Cyclic Shocks, Leverage Effect

JEL Classification: C32, E32, G01, G21