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Risk-Factor Portfolios and Financial Stability

  • Garita, Gus

This paper defines a risk-stability index (RSI) that takes into account the extreme dependence structure and the conditional probability of joint failure (CPJF) among risk factors in a portfolio. In combination, both the RSI and CPJF provide a valuable tool for analyzing risk from complementary perspectives; thereby allowing the measurement of (i) common distress of risk factors in a portfolio, (ii) distress between specific risk factors, and (iii) distress to a portfolio related to a specific risk factor. With an application to a financial system comprised of 18 banks from around the world, the results herein show that financial stability must be viewed as a continuum, since risk varies from period to period. The risk-stability index indicates that U.S. banks tend to cause the most stress to the global financial system (as defined herein), followed by Asian and European banks. The results also show that Asian banks seem to experience the most persistence of distress, followed by U.S. and European banks. The panel VAR results show that monetary policy should "lean against the wind", since it has a significant effect in reducing the (potential) instability of a financial system.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 19611.

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Date of creation: 11 Dec 2009
Date of revision: 11 Dec 2009
Handle: RePEc:pra:mprapa:19611
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  1. Gus Garita & Chen Zhou, 2009. "Can Open Capital Markets Help Avoid Currency Crises?," DNB Working Papers 205, Netherlands Central Bank, Research Department.
  2. Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2005. "A risk assessment model for banks," Annals of Finance, Springer, vol. 1(2), pages 197-224, 09.
  3. 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.).
  4. Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2003. "A Model to Analyse Financial Fragility," OFRC Working Papers Series 2003fe13, Oxford Financial Research Centre.
  5. Love, Inessa & Zicchino, Lea, 2006. "Financial development and dynamic investment behavior: Evidence from panel VAR," The Quarterly Review of Economics and Finance, Elsevier, vol. 46(2), pages 190-210, May.
  6. Kristin J. Forbes & Roberto Rigobon, 2002. "No Contagion, Only Interdependence: Measuring Stock Market Comovements," Journal of Finance, American Finance Association, vol. 57(5), pages 2223-2261, October.
  7. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
  8. Philipp Hartmann & Stefan Straetmans & Casper G. de Vries, 2001. "Asset market linkages in crisis periods," Proceedings 727, Federal Reserve Bank of Chicago.
  9. Lehar, Alfred, 2005. "Measuring systemic risk: A risk management approach," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2577-2603, October.
  10. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
  11. Franklin Allen & Ana Babus & Elena Carletti, 2009. "Financial Crises: Theory and Evidence," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 97-116, November.
  12. Holtz-Eakin, Douglas & Newey, Whitney & Rosen, Harvey S, 1988. "Estimating Vector Autoregressions with Panel Data," Econometrica, Econometric Society, vol. 56(6), pages 1371-95, November.
  13. Charles Goodhart & Miguel Segoviano, 2009. "Banking Stability Measures," FMG Discussion Papers dp627, Financial Markets Group.
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