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Measuring the frequency dynamics of financial connectedness and systemic risk

Listed author(s):
  • Jozef Barunik
  • Tomas Krehlik

Risk management has generally focused on aggregate connectedness, overlooking its cyclical sources. We argue that the frequency dynamics is insightful for studying this connectedness because shocks with heterogeneous frequency responses create linkages with various degrees of persistence. Such connections are important for understanding the possible sources of systemic risk specific to economic cycles but remain hidden when aggregate measures of connectedness are used. To estimate connectedness on short-, medium-, and long-term financial cycles, we propose a general framework based on spectral representation of variance decompositions. In an empirical application, we document the rich dynamics of volatility connectedness in the US financial institutions with short-term connections due to contemporaneous correlations as well as significant weekly, monthly, and longer connections that play a role. Hence, we find that the financial market clears part of the information but that the permanent changes in investors' expectations having longer-term responses are non-negligible.

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File URL: http://arxiv.org/pdf/1507.01729
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Paper provided by arXiv.org in its series Papers with number 1507.01729.

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Date of creation: Jul 2015
Date of revision: Apr 2017
Handle: RePEc:arx:papers:1507.01729
Contact details of provider: Web page: http://arxiv.org/

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