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Forecasting the fragility of the banking and insurance sector

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Author Info
Kerstin Bernoth
Andreas Pick
Abstract

This paper considers the issue of forecasting financial fragility of banks and insurances using a panel data set of performance indicators, namely distance-to-default, taking unobserved common factors into account. We show that common factors are important in the performance of banks and insurances, analyze the influences of a number of observable factors on banking and insurance performance, and evaluate the forecasts from our model. We find that taking unobserved common factors into account reduces the root mean square forecasts error of  firm specific forecasts by up to 11% and of system forecasts by up to 29% relative to a model based only on observed variables. Estimates of the factor loadings suggest that the correlation of financial institutions has been relatively stable over the forecast period.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 202.

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Date of creation: Feb 2009
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Handle: RePEc:dnb:dnbwpp:202

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Related research
Keywords: Financial stability; financial linkages; banking; insurances; unobserved common factors; forecasting;

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Find related papers by JEL classification:
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies

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