Anticipating the Bust: A New Cyclical Systemic Risk Indicator to Assess the Likelihood and Severity of Financial Crises

77 Pages Posted: 15 Feb 2019

See all articles by Jan Hannes Lang

Jan Hannes Lang

European Central Bank (ECB)

Cosimo Izzo

University College London

Stephan Fahr

European Central Bank

Josef Ruzicka

Universidad Carlos III de Madrid

Date Written: February 14, 2019

Abstract

This paper presents a tractable, transparent and broad-based domestic cyclical systemic risk indicator (d-SRI) that captures risks stemming from domestic credit, real estate markets, asset prices, and external imbalances. The d-SRI increases on average several years before the onset of systemic financial crises, and its early warning properties for euro area countries are superior to those of the total credit-to-GDP gap. In addition, the level of the d-SRI around the start of financial crises is highly correlated with measures of subsequent crisis severity, such as GDP declines. Model estimates suggest that the d-SRI has significant predictive power for large declines in real GDP growth three to four years down the line, as it precedes shifts in the entire distribution of future real GDP growth and especially of its left tail. The d-SRI therefore provides useful information about both the probability and the likely cost of systemic financial crises many years in advance. Given its timely signals, the d-SRI is a useful analytical tool for macroprudential policymakers.

Keywords: systemic risk, financial crises, early warning models, quantile regressions, local projections, GDP at risk

JEL Classification: G01, G17, C22, C54

Suggested Citation

Lang, Jan Hannes and Izzo, Cosimo and Fahr, Stephan Alexander and Ruzicka, Josef, Anticipating the Bust: A New Cyclical Systemic Risk Indicator to Assess the Likelihood and Severity of Financial Crises (February 14, 2019). ECB Occasional Paper No. 219 (2019); ISBN 978-92-899-3683-5. Available at SSRN: https://ssrn.com/abstract=3334835

Jan Hannes Lang (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Cosimo Izzo

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

Stephan Alexander Fahr

European Central Bank ( email )

Kaiserstr. 29
Frankfurt am Main, DE 60066
Germany

Josef Ruzicka

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

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