Systemic Risk Diagnostics
AbstractA macro-prudential policy maker can manage risks to financial stability only if currentand future risks can be reliably assessed. We propose a novel framework to assessfinancial system risk. Using a dynamic factor framework based on state-space methods, we model latent macro-financial and credit risk components for a large data setcomprising the U.S., the EU-27 area, and the rest of the world. Controlling for global,region-specific, and industry effects, we construct coincident measures ('thermometers')and forward looking indicators of financial distress and the likelihood of financial melt-down. We find that credit risk conditions can significantly and persistently de-couplefrom macro-financial fundamentals. Such decoupling can serve as an early warningsignal for macro-prudential policy.
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 10-104/2/DSF 2.
Date of creation: 18 Oct 2010
Date of revision: 29 Nov 2010
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financial crisis; systemic risk; credit portfolio models; frailty-correlated defaults; state space methods;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-10-30 (All new papers)
- NEP-BAN-2010-10-30 (Banking)
- NEP-ORE-2010-10-30 (Operations Research)
- NEP-RMG-2010-10-30 (Risk Management)
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