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The Formation Mechanism of Systemic Financial Risk under External Shocks

Author

Listed:
  • FANG Yi

    (School of Finance, Central University of Finance and Economics, Beijing 100083, China)

  • JING Zhongbo

    (School of Management Science and Engineering, Central University of Finance and Economics, Beijing 100083, China)

Abstract

By incorporating both the fire sales contagion mechanism and the bankruptcy contagion mechanism into a bank network model, this paper examines how risks are generated under dynamic shocks. In particular, this paper constructs systemic risk indicators suitable for analyzing multiple rounds of contagion under different shocks (time dimension) and from institutions and assets (spatial dimension). Indicators that measure the indirect relevance between institutions and between assets are also innovatively built. It is found that due to deleveraging or bankruptcy among a large number of banks, the systemic risk exhibits an upward trend marked by intermittent jumps under varying intensities of shocks. Risks are generated mainly through the fire sales contagion mechanism of deleveraging under small shocks, and through the bankruptcy contagion mechanism under large shocks. In terms of influencing factors, a stronger indirect relevance, a lower leverage skewness and a higher leverage level in the banking system lead to higher risks. In particular, the influence of leverage skewness on systemic risk is stronger than that of leverage level.

Suggested Citation

  • FANG Yi & JING Zhongbo, 2023. "The Formation Mechanism of Systemic Financial Risk under External Shocks," Frontiers of Economics in China-Selected Publications from Chinese Universities, Higher Education Press, vol. 18(2), pages 198-243, June.
    • Handle: RePEc:fec:journl:v:18:y:2023:i:2:p:198-243
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    File URL: https://journal.hep.com.cn/fec/EN/10.3868/s060-017-023-0010-2
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