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Can we prove a bank guilty of creating systemic risk?: a minority report

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Listed:
  • Danielsson, Jon
  • James, Kevin R.
  • Valenzuela, Marcela
  • Zer, Ilknur

Abstract

Since increasing a bank's capital requirement to improve the stability of the financial system imposes costs upon the bank, a regulator should ideally be able to prove beyond a reasonable doubt that banks classified as systemically risky really do create systemic risk before subjecting them to this capital punishment. Evaluating the performance of two leading systemic risk models, we show that estimation error alone prevents the reliable identification of the most systemically risky banks. We conclude that it will be a considerable challenge to develop a riskometer that is both sound and reliable enough to provide an adequate foundation for macroprudential policy.

Suggested Citation

  • Danielsson, Jon & James, Kevin R. & Valenzuela, Marcela & Zer, Ilknur, 2015. "Can we prove a bank guilty of creating systemic risk?: a minority report," LSE Research Online Documents on Economics 65097, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:65097
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    File URL: http://eprints.lse.ac.uk/65097/
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    References listed on IDEAS

    as
    1. Jeremy Berkowitz & James O'Brien, 2002. "How Accurate Are Value-at-Risk Models at Commercial Banks?," Journal of Finance, American Finance Association, vol. 57(3), pages 1093-1111, June.
    2. Sylvain Benoit & Gilbert Colletaz & Christophe Hurlin & Christophe Pérignon, 2013. "A Theoretical and Empirical Comparison of Systemic Risk Measures," Working Papers halshs-00746272, HAL.
    3. Daníelsson, Jón, 2008. "Blame the models," Journal of Financial Stability, Elsevier, vol. 4(4), pages 321-328, December.
    4. Dimitrios Bisias & Mark Flood & Andrew W. Lo & Stavros Valavanis, 2012. "A Survey of Systemic Risk Analytics," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 255-296, October.
    5. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Proceedings 512, Federal Reserve Bank of Chicago.
    6. López-Espinosa, Germán & Moreno, Antonio & Rubia, Antonio & Valderrama, Laura, 2012. "Short-term wholesale funding and systemic risk: A global CoVaR approach," Journal of Banking & Finance, Elsevier, vol. 36(12), pages 3150-3162.
    7. Idier, Julien & Lamé, Gildas & Mésonnier, Jean-Stéphane, 2014. "How useful is the Marginal Expected Shortfall for the measurement of systemic exposure? A practical assessment," Journal of Banking & Finance, Elsevier, vol. 47(C), pages 134-146.
    8. Danielsson, Jon, 2002. "The emperor has no clothes: Limits to risk modelling," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1273-1296, July.
    9. Viral Acharya & Robert Engle & Matthew Richardson, 2012. "Capital Shortfall: A New Approach to Ranking and Regulating Systemic Risks," American Economic Review, American Economic Association, vol. 102(3), pages 59-64, May.
    10. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 39-69.
    11. Anat Admati & Martin Hellwig, 2013. "The Bankers' New Clothes: What's Wrong with Banking and What to Do about It," Economics Books, Princeton University Press, edition 1, number 9929.
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    Citations

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    Cited by:

    1. Chiara Pederzoli & Costanza Torricelli, 2017. "Systemic risk measures and macroprudential stress tests: an assessment over the 2014 EBA exercise," Annals of Finance, Springer, vol. 13(3), pages 237-251, August.
    2. repec:eee:jimfin:v:82:y:2018:i:c:p:45-70 is not listed on IDEAS
    3. Kubitza, Christian & Gründl, Helmut, 2016. "Systemic risk: Time-lags and persistence," ICIR Working Paper Series 20/16, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    4. Tente, Natalia & von Westernhagen, Natalja & Slopek, Ulf, 2017. "M-PRESS-CreditRisk: A holistic micro- and macroprudential approach to capital requirements," Discussion Papers 15/2017, Deutsche Bundesbank.
    5. repec:kap:annfin:v:14:y:2018:i:4:d:10.1007_s10436-018-0326-3 is not listed on IDEAS
    6. Danielsson, Jon & James, Kevin R. & Valenzuela, Marcela & Zer, Ilknur, 2016. "Model risk of risk models," Journal of Financial Stability, Elsevier, vol. 23(C), pages 79-91.
    7. Jokivuolle, Esa & Tunaru, Radu & Vioto, Davide, 2018. "Testing the systemic risk differences in banks," Research Discussion Papers 13/2018, Bank of Finland.
    8. repec:eee:intfor:v:34:y:2018:i:3:p:440-455 is not listed on IDEAS

    More about this item

    Keywords

    Systemic risk; macroprudential policy; financial stability; risk management;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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