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On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms

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  • Francis X. Diebold

    ()
    (Department of Economics, University of Pennsylvania)

  • Kamil Yılmaz

    ()
    (Department of Economics, Koç University)

Abstract

We propose several connectedness measures built from pieces of variance decompositions, and we argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. We also show that variance decompositions define weighted, directed networks, so that our connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, we 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 Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 11-031.

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Length: 36 pages
Date of creation: 30 Sep 2011
Date of revision:
Handle: RePEc:pen:papers:11-031

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Keywords: Risk measurement; risk management; portfolio allocation; market risk; credit risk; systemic risk; asset markets; degree distribution;

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References

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  1. Morten L. Bech & Enghin Atalay, 2008. "The topology of the federal funds market," Staff Reports 354, Federal Reserve Bank of New York.
  2. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  3. Francis X. Diebold & Kamil Yilmaz, 2007. "Measuring Financial Asset Return and Volatility Spillovers, With Application to Global Equity Markets," PIER Working Paper Archive 07-002, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  4. Jean-Marie Dufour & Abderrahim Taamouti, 2008. "Short and long run causality measures: theory and inference," Economics Working Papers we083720, Universidad Carlos III, Departamento de Economía.
  5. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
  6. 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.
  7. 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.
  8. Marcella Lucchetta & Gianni De Nicoló, 2012. "Systemic Real and Financial Risks," IMF Working Papers 12/58, International Monetary Fund.
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