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Early warning of systemic risk in global banking: eigen-pair R number for financial contagion and market price-based methods

Author

Listed:
  • Sheri Markose

    (University of Essex)

  • Simone Giansante

    (University of Bath)

  • Nicolas A. Eterovic

    (University of Essex)

  • Mateusz Gatkowski

    (University of Essex
    European Central Bank)

Abstract

We analyse systemic risk in the core global banking system using a new network-based spectral eigen-pair method, which treats network failure as a dynamical system stability problem. This is compared with market price-based Systemic Risk Indexes (SRIs), viz. Marginal Expected Shortfall (MES), Delta Conditional Value-at-Risk (Delta-CoVaR), and Conditional Capital Shortfall Measure of Systemic Risk (SRISK) in a cross-border setting. Unlike paradoxical market price based risk measures, which underestimate risk during periods of asset price booms, the eigen-pair method based on bilateral balance sheet data gives early-warning of instability in terms of the tipping point that is analogous to the R number in epidemic models. For this regulatory capital thresholds are used. Furthermore, network centrality measures identify systemically important and vulnerable banking systems. Market price-based SRIs are contemporaneous with the crisis and they are found to covary with risk measures like VaR and betas.

Suggested Citation

  • Sheri Markose & Simone Giansante & Nicolas A. Eterovic & Mateusz Gatkowski, 2023. "Early warning of systemic risk in global banking: eigen-pair R number for financial contagion and market price-based methods," Annals of Operations Research, Springer, vol. 330(1), pages 691-729, November.
    • Handle: RePEc:spr:annopr:v:330:y:2023:i:1:d:10.1007_s10479-021-04120-1
    DOI: 10.1007/s10479-021-04120-1
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