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The Multivariate Option iPoD Framework - Assessing Systemic Financial Risk

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  • Philipp Matros
  • Johannes Vilsmeier

Abstract

We derive multivariate risk neutral asset distributions for major US nancial institutions (FIs) using option implied marginal risk neutral asset distributions (RNDs) and probabili- ties of default (PoDs). The multivariate densities are estimated by combining the entropy approach, dynamic copulas and rank correlations. Our density estimates exhibit information about the conditional distributions of the individual FIs and we propose several nancial distress measures based on default scenarios taking place in the nancial sector. Empirical results around the period of the US sub-prime crisis show that the proposed risk measures in a timely manner identify i) the most troubled FIs in the system, ii) the systemically most important FIs, iii) the implicit bailout guarantees of some FIs and iv) a `too interconnected to fail' problem in the US nancial sector throughout the year 2008.

Suggested Citation

  • Philipp Matros & Johannes Vilsmeier, 2013. "The Multivariate Option iPoD Framework - Assessing Systemic Financial Risk," Working Papers 143, Bavarian Graduate Program in Economics (BGPE).
    • Handle: RePEc:bav:wpaper:143_matrosvilsmeier
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial Distress; Conditional Probability of Default; Copulae; Option Prices; Entropy Principle;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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