Systemic Risk in the Financial System: Capital Shortfalls Under Brexit, the US Elections and the Italian Referendum

24 Pages Posted: 14 Dec 2018

See all articles by Robert F. Engle

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Cristiano Zazzara

Libera Università degli Studi Sociali (LUISS) Guido Carli - Fondo Interbancario di Tutela dei Depositi and Instituto di Studi Economici

Date Written: December 11, 2018

Abstract

Recent episodes of stress in the financial system have fostered a great deal of discussion regarding new supervisory and regulatory tools for financial institutions. The recent introduction of additional capital requirements for systemically important financial institutions is one example of the concrete measures that are being taken by regulators to mitigate systemic risk. In order to assist market participants in assessing and tracking systemic risk in the financial system, the Volatility Laboratory of the NYU Stern School of Business developed a quantitative indicator, called SRISK, which estimates the expected capital shortfall faced by a firm in a potential future financial crisis. Conceptually, SRISK is similar to the stress tests that are regularly applied to financial institutions; however, it is based exclusively on publicly available information (market and accounting data) and is quick and inexpensive to compute. Those firms with a high capital shortfall in a crisis – that is, when capital is low in the financial system – are the ones with the potential to extend the crisis and impact the broader economy. We use SRISK to quantify the estimated capital shortfalls of financial institutions under three relevant stress events that occurred in 2016: Brexit, the Trump election and the Italian referendum. We refer to these events collectively as BRUMPIT. Our empirical results confirm the usefulness of SRISK in assessing the sensitivity of individual financial institutions to the BRUMPIT events. This highlights the transmission channels in terms of systemic risk.

Keywords: systemic risk, stress testing, regulatory capital requirements, forecasting methods.

Suggested Citation

Engle, Robert F. and Zazzara, Cristiano, Systemic Risk in the Financial System: Capital Shortfalls Under Brexit, the US Elections and the Italian Referendum (December 11, 2018). Journal of Credit Risk, Vol. 14, No. 4, 2018. Available at SSRN: https://ssrn.com/abstract=3299511

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Cristiano Zazzara (Contact Author)

Libera Università degli Studi Sociali (LUISS) Guido Carli - Fondo Interbancario di Tutela dei Depositi and Instituto di Studi Economici ( email )

00162 Rome, Roma
Italy
+39 06 699 86 402 (Phone)

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