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On the network topology of variance decompositions: Measuring the connectedness of financial firms

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  • Francis X. Diebold
  • Kamil Yilmaz

Abstract

The authors propose several connectedness measures built from pieces of variance decompositions, and they argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. The authors also show that variance decompositions define weighted, directed networks, so that their connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, the authors track both average and daily time-varying connectedness of major U.S. financial institutions' stock return volatilities in recent years, including during the financial crisis of 2007-2008.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 11-45.

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Date of creation: 2011
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Handle: RePEc:fip:fedpwp:11-45

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Keywords: Portfolio management ; Systemic risk ; Risk management;

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  1. Francis X. Diebold & Kamil Yılmaz, 2007. "Measuring Financial Asset Return and Volatility Spillovers, With Application to Global Equity Markets," Koç University-TUSIAD Economic Research Forum Working Papers 0705, Koc University-TUSIAD Economic Research Forum.
  2. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Working Papers 16177, National Bureau of Economic Research, Inc.
  3. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
  4. Dufour, Jean-Marie & Taamouti, Abderrahim, 2010. "Short and long run causality measures: Theory and inference," Journal of Econometrics, Elsevier, vol. 154(1), pages 42-58, January.
  5. Morten L. Bech & Enghin Atalay, 2008. "The topology of the federal funds market," Staff Reports 354, Federal Reserve Bank of New York.
  6. Wolfgang Karl Härdle & Ostap Okhrin & Yarema Okhrin, 2010. "Time varying Hierarchical Archimedean Copulae," SFB 649 Discussion Papers SFB649DP2010-018, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  7. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
  8. Marcella Lucchetta & Gianni De Nicoló, 2012. "Systemic Real and Financial Risks," IMF Working Papers 12/58, International Monetary Fund.
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