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Variation in Systemic Risk at US Banks During 1974-2010

  • Armen Hovakimian
  • Edward J. Kane
  • Luc Laeven

This paper proposes a theoretically sound and easy-to-implement way to measure the systemic risk of financial institutions using publicly available accounting and stock market data. The measure models credit risk of banks as a put option on bank assets, a tradition that originated with Merton (1974). We extend his contribution by expressing the value of banking-sector losses from systemic default risk as the value of a put option written on a portfolio of aggregate bank assets whose exercise price equals the face value of aggregate bank debt. We conceive of an individual bank's systemic risk as its contribution to the value of this potential sector-wide put on the financial safety net. To track the interaction of private and governmental sources of systemic risk during and in advance of successive business-cycle contractions, we apply our model to quarterly data over the period 1974-2010. Results indicate that systemic risk reached unprecedented highs during the years 2008-2010, and that bank size, leverage, and asset risk are key drivers of systemic risk.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18043.

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Date of creation: May 2012
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Handle: RePEc:nbr:nberwo:18043
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