Systemic Real and Financial Risks: Measurement, Forecasting, and Stress Testing

Gianni De Nicolo, Marcella Lucchetta
2011 Social Science Research Network  
Building on De Nicolò and Lucchetta (2010) , this paper presents a novel modeling framework that delivers: (a) density forecasts of indicators of real activity and financial health, and implied indicators of systemic real risk and systemic financial risk; (b) reduced-form stress tests as historical simulations, and structural stress-tests as impulse responses of systemic risk indicators to structural shocks identified by standard macroeconomic and banking theory. This framework is implemented
more » ... rk is implemented using large sets of quarterly time series of indicators of financial and real activity for the G-7 economies in 1980Q1-2010Q2. We show that the model exhibits significant out-of sample forecasting power for tail real and financial risk realizations in each country and stress tests provide important early warnings on the build-up of real and financial vulnerabilities. Furthermore, we find that in all countries aggregate demand shocks are the main drivers of the real cycle, and bank credit demand shocks are the main drivers of the bank lending cycle: these results suggest that sharp declines in real activity may have been the key drivers of the observed decline of bank credit in the G-7 economies in the aftermath of Lehman's collapse in 2008Q3. JEL Classification Numbers: C5; E3; G2
doi:10.2139/ssrn.1763852 fatcat:xealqfbnhbebzfhpmssmzddxuy