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Distress Dependence and Financial Stability

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  • Miguel A. Segoviano
  • Charles Goodhart
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    Abstract

    This paper defines a set of systemic financial stability indicators which measure distress dependence among the financial institutions in a system, thereby allowing to analyze stability from three complementary perspectives: common distress in the system, distress between specific banks, and cascade effects associated with a specific bank. Our approach defines the banking system as a portfolio of banks and infers the system’s multivariate density (BSMD) from which the proposed measures are estimated. The BSMD embeds the banks’ default inter-dependence structure that captures linear and non-linear distress dependencies among the banks in the system, and its changes at different times of the economic cycle. The BSMD is recovered using the CIMDO-approach, a new approach that, in the presence of restricted data, improves density specification without explicitly imposing parametric forms that, under restricted data sets, are difficult to model. Thus, the proposed measures can be constructed from a very limited set of publicly available data and can be provided for a wide range of both developing and developed countries.

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    Bibliographic Info

    Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 569.

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    Date of creation: Apr 2010
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    Handle: RePEc:chb:bcchwp:569

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    References

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    1. Charles Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A model to analyse financial fragility," LSE Research Online Documents on Economics 24703, London School of Economics and Political Science, LSE Library.
    2. Miguel Angel Segoviano & Philip Lowe, 2002. "Internal ratings, the business cycle, and capital requirements: some evidence from an emerging market economy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston.
    3. Philip Lowe & Miguel A. Segoviano, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," BIS Working Papers 117, Bank for International Settlements.
    4. Diebold, Francis X & Gunther, Todd A & Tay, Anthony S, 1998. "Evaluating Density Forecasts with Applications to Financial Risk Management," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 863-83, November.
    5. Miguel Segoviano, 2006. "Consistent Information Multivariate Density Optimizing Methodology," FMG Discussion Papers dp557, Financial Markets Group.
    6. C.G. de vries, 2004. "The simple economics of bank fragility," WO Research Memoranda (discontinued) 755, Netherlands Central Bank, Research Department.
    7. Charles Goodhart & Boris Hofmann & Miguel Segoviano, 2004. "Bank Regulation and Macroeconomic Fluctuations," Oxford Review of Economic Policy, Oxford University Press, vol. 20(4), pages 591-615, Winter.
    8. Philip Lowe, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," FMG Discussion Papers dp428, Financial Markets Group.
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