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Systemic risk and financial consolidation: are they related?

  • Gianni De Nicolo
  • Myron L. Kwast
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    The creation of a number of very large and sometimes increasingly complex financial institutions, resulting in part from the on-going consolidation of the financial system, has raised concerns that the degree of systemic risk in the financial system may have increased. We argue that firm interdependencies, as measured by correlations of stock returns, provide an indicator of systemic risk potential. We analyze the dynamics of the stock return correlations of a sample of U.S. large and complex banking organizations (LCBOs) over 1988-1999, and find a significant positive trend in stock return correlations. In addition, we relate firms' return correlations to their consolidation activity. Consolidation at the sample LCBOs appears to have contributed to LCBOs interdependencies. However, consolidation elasticities of correlation exhibit substantial time variation, and likely declined in the latter part of the decade. Thus, factors other than consolidation have also been responsible for the upward trend in return correlations.

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    File URL: http://www.federalreserve.gov/pubs/feds/2001/200133/200133abs.html
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    File URL: http://www.federalreserve.gov/pubs/feds/2001/200133/200133pap.pdf
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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-33.

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    Date of creation: 2001
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    Handle: RePEc:fip:fedgfe:2001-33
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    1. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
    2. De Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic risk: A survey," Working Paper Series 0035, European Central Bank.
    3. John Y. Campbell & Martin Lettau & Burton G. Malkiel & Yexiao Xu, 2000. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," NBER Working Papers 7590, National Bureau of Economic Research, Inc.
    4. Brian H. Boyer & Michael S. Gibson & Mico Loretan, 1997. "Pitfalls in tests for changes in correlations," International Finance Discussion Papers 597, Board of Governors of the Federal Reserve System (U.S.).
    5. anonymous, 1999. "Using subordinated debt as an instrument of market discipline," Staff Studies 172, Board of Governors of the Federal Reserve System (U.S.).
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