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Multivariate dependence of implied volatilities from equity options as measure of systemic risk

  • Jobst, Andreas A.

This paper presents a methodology to examine the multivariate tail dependence of the implied volatility of equity options as an early warning indicator of systemic risk within the financial sector. Using non-parametric methods of estimating changes in the dependence structure in response to common shocks affecting individual risk profiles, possible linkages during periods of stress are quantifiable while recognizing that large shocks are transmitted across financial markets differently than small shocks. Before and during the initial phase of the financial crisis, we find that systemic risk increased globally as early as February 2007 — months before the unraveling of the U.S. subprime mortgage crisis and long before the collapse of Lehman Brothers. The average (multivariate) dependence among a global sample of banks and insurance companies increased by almost 30% while joint tail risk declined by about the same order of magnitude, indicating that co-movements of large changes in equity volatility were more likely to occur and responses to extreme shocks became more differentiated as distress escalated. The key policy consideration flowing from our analysis is that complementary measures of joint tail risk at high data frequency are essential to the robust measurement of systemic risk, which could enhance market-based early warning mechanisms as part of macroprudential surveillance.

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Article provided by Elsevier in its journal International Review of Financial Analysis.

Volume (Year): 28 (2013)
Issue (Month): C ()
Pages: 112-129

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Handle: RePEc:eee:finana:v:28:y:2013:i:c:p:112-129
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620166

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  1. Andreas Jobst, 2007. "Operational Risk; The Sting is Still in the Tail But the Poison Dependson the Dose," IMF Working Papers 07/239, International Monetary Fund.
  2. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Working Papers 16177, National Bureau of Economic Research, Inc.
  3. International Monetary Fund, 2011. "United Kingdom; Stress Testing the Banking Sector Technical Note," IMF Staff Country Reports 11/227, International Monetary Fund.
  4. Mathias Drehmann & Nikola Tarashev, 2011. "Systemic importance: some simple indicators," BIS Quarterly Review, Bank for International Settlements, March.
  5. Huang, Xin & Zhou, Hao & Zhu, Haibin, 2009. "A framework for assessing the systemic risk of major financial institutions," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 2036-2049, November.
  6. Acharya, Viral V & Pedersen, Lasse H & Philippon, Thomas & Richardson, Matthew P, 2012. "Measuring Systemic Risk," CEPR Discussion Papers 8824, C.E.P.R. Discussion Papers.
  7. de Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic Risk: A Survey," CEPR Discussion Papers 2634, C.E.P.R. Discussion Papers.
  8. Xin Huang & Hao Zhou & Haibin Zhu, 2010. "Assessing the systemic risk of a heterogeneous portfolio of banks during the recent financial crisis," BIS Working Papers 296, Bank for International Settlements.
  9. International Monetary Fund, 2010. "United States; Publication of Financial Sector Assessment Program Documentation: Technical Note on Stress Testing," IMF Staff Country Reports 10/244, International Monetary Fund.
  10. International Monetary Fund, 2011. "Germany; Technical Note on Stress Testing," IMF Staff Country Reports 11/371, International Monetary Fund.
  11. Andreas Jobst, 2012. "Measuring Systemic Risk-Adjusted Liquidity (SRL); A Model Approach," IMF Working Papers 12/209, International Monetary Fund.
  12. International Monetary Fund, 2012. "Spain; Financial System Stability Assessment," IMF Staff Country Reports 12/137, International Monetary Fund.
  13. Jorge A. Chan-Lau, 2010. "Regulatory Capital Charges for too-Connected-To-Fail Institutions; A Practical Proposal," IMF Working Papers 10/98, International Monetary Fund.
  14. Monica Billio & Mila Getmansky & Andrew W. Lo & Loriana Pelizzon, 2010. "Econometric Measures of Systemic Risk in the Finance and Insurance Sectors," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  15. Henri Theil, 1969. "On the use of Information Theory Concepts in the Analysis of Financial Statements," Management Science, INFORMS, vol. 15(9), pages 459-480, May.
  16. Claudio E. V. Borio, 2003. "Towards a macroprudential framework for financial supervision and regulation?," BIS Working Papers 128, Bank for International Settlements.
  17. Marco A. Espinosa-Vega & Juan Solé, 2011. "Cross-border financial surveillance: a network perspective," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 3(3), pages 182-205, August.
  18. Yamai, Yasuhiro & Yoshiba, Toshinao, 2005. "Value-at-risk versus expected shortfall: A practical perspective," Journal of Banking & Finance, Elsevier, vol. 29(4), pages 997-1015, April.
  19. Dimitrios Bisias & Mark Flood & Andrew W. Lo & Stavros Valavanis, 2012. "A Survey of Systemic Risk Analytics," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 255-296, October.
  20. Viral Acharya & Robert Engle & Matthew Richardson, 2012. "Capital Shortfall: A New Approach to Ranking and Regulating Systemic Risks," American Economic Review, American Economic Association, vol. 102(3), pages 59-64, May.
  21. Allen, F. & Babus, A. & Carletti, E., 2010. "Financial Connections and Systemic Risk," Discussion Paper 2010-88S, Tilburg University, Center for Economic Research.
  22. International Monetary Fund, 2011. "Sweden; Financial Sector Assessment Program Update: Technical Note on Contingent Claims Analysis Approach to Measure Risk and Stress Test the Swedish Banking Sector," IMF Staff Country Reports 11/286, International Monetary Fund.
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  25. Viral V. Acharya, 2010. "Measuring systemic risk," Proceedings 1140, Federal Reserve Bank of Chicago.
  26. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-50, July.
  27. Buchen, Peter W. & Kelly, Michael, 1996. "The Maximum Entropy Distribution of an Asset Inferred from Option Prices," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(01), pages 143-159, March.
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