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Shadow banking and the dynamics of aggregate leverage: An application of the Kalman filter to cyclical leverage measures

Author

Listed:
  • Christian Calmès

    () (Département des sciences administratives, Université du Québec (Outaouais), Chaire d'information financière et organisationnelle, ESG-UQAM, and Laboratory for Research in Statistics and Probability)

  • Raymond Théoret

    () (Département de finance, Université du Québec (Montréal), Chaire d'information financière et organisationnelle, ESG-UQAM, and Université du Québec (Outaouais))

Abstract

During the last decades, banks off-balance sheet (OBS) activities (e.g. securitization, trading and fee-based activities) have greatly contributed to the increase in bank risk. However, the standard financial indicators such as the Value-at-Risk and the accounting leverage, exclude these non-traditional activities, and neglect the increased risk market-oriented banking generates. In this paper, we study various measures of leverage in the context of shadow banking, relying on a dynamic setting, which features Kalman filter procedures and different detrending methods. Applying this framework to Canadian data, we can detect the increase in risk associated to banks new business lines years before what the conventional risk measures predict. We also find that the elasticity measures of leverage, compared to the simple balance sheet ratios like the ratio of assets to equity or the mandatory leverage measure, are generally more forward-looking indicators of bank risk, and better capture the cyclical pattern of bank leverage. The main contribution of this paper is to show that OBS activities exert a stronger influence on these leverage measures during expansion periods.

Suggested Citation

  • Christian Calmès & Raymond Théoret, 2011. "Shadow banking and the dynamics of aggregate leverage: An application of the Kalman filter to cyclical leverage measures," RePAd Working Paper Series UQO-DSA-wp022011, Département des sciences administratives, UQO.
  • Handle: RePEc:pqs:wpaper:022011
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    File URL: http://www.repad.org/ca/qc/uq/uqo/dsa/lev012011.pdf
    File Function: First version, 2011
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    More about this item

    Keywords

    Leverage; Banking; Off-balance sheet activities; Liquidity; Kalman Filter.;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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