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Decomposing systemic risk: the roles of contagion and common exposures

Author

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  • Hałaj, Grzegorz
  • Hipp, Ruben

Abstract

We evaluate the effects of contagion and common exposure on banks’ capital through a regression design inspired by the structural VAR literature and derived from the balance sheet identity. Contagion can occur through direct exposures, fire sales, and market-based sentiment, while common exposures result from portfolio overlaps. We estimate the structural regression on granular balance sheet and interbank exposure data of the Canadian banking market. First, we document that contagion varies in time, with the highest levels around the Great Financial Crisis and lowest levels during the pandemic. Second, we find that after the introduction of Basel III the relative importance of risks has changed, hinting that sources of systemic risk have changed structurally. Our new framework complements traditional stress-tests focused on single institutions by providing a holistic view of systemic risk. JEL Classification: G21, C32, C51, L14

Suggested Citation

  • Hałaj, Grzegorz & Hipp, Ruben, 2024. "Decomposing systemic risk: the roles of contagion and common exposures," Working Paper Series 2929, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20242929
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2929~19cda4a673.en.pdf
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    More about this item

    Keywords

    banking; contagion; networks; structural estimation; systemic risk;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • 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
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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