Systemic Risk: Time-Lags and Persistence

Christian Kubitza
2016 Social Science Research Network  
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more » ... bedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Abstract Common systemic risk measures focus on the instantaneous occurrence of triggering and systemic events. However, systemic events may also occur with a time-lag to the triggering event. To study this contagion period and the resulting persistence of institutions' systemic risk we develop and employ the Conditional Shortfall Probability (CoSP), which is the likelihood that a systemic market event occurs with a specific time-lag to the triggering event. Based on CoSP we propose two aggregate systemic risk measures, namely the Aggregate Excess CoSP and the CoSP-weighted time-lag, that reflect the systemic risk aggregated over time and average time-lag of an institution's triggering event, respectively. Our empirical results show that 15% of the financial companies in our sample are significantly systemically important with respect to the financial sector, while 27% of the financial companies are significantly systemically important with respect to the American non-financial sector. Still, the aggregate systemic risk of systemically important institutions is larger with respect to the financial market than with respect to non-financial markets. Moreover, the aggregate systemic risk of insurance companies is similar to the systemic risk of banks, while insurers are also exposed to the largest aggregate systemic risk among the financial sector. JEL Classification: G01, G14, G15, G20 * We are grateful for helpful comments and suggestions by Elia Berdin, Mario Brandtner, Wolfgang Kürsten and Christian Pigorsch. Any errors are our own. § Both authors are affiliated with the According to the Committee on Capital Markets Regulation (2009, p. ES-3) systemic risk is "the risk of collapse of an entire system or entire market, exacerbated by links and interdependencies, where the failure of a single entity or cluster of entities can cause a cascading failure". This definition was also adopted by the Financial Stability Board (2011, p. 5) in the sense, that an institution or market is considered as being systemic if its "failure or malfunction causes widespread distress, either as a direct impact or as a trigger for broader contagion". Thus, systemic risk is usually connoted with the risk of contagion and spillover effects. 1 These effects may result from direct linkages between firms, i.e. counterparty contagion. Additionally, contagion may evolve from indirect linkages due to the exposure to common risk factors (see Chan-Lau et al. (2009)), for example asset prices, or (over-)reactions of market participants like fire sales of securities, bank runs, or insurance runs, in particular through mass surrenders in life insurance. 2 As Harrington (2009) points out, contagious reactions typically evolve over time and, thus, responses to shocks may be delayed: Since systemic distress is a result of triggering events that cause (the lack of) cash-flows -or the information about (the lack of) cash-flows -, systemic risk migrates from institution to institution through their interconnectedness. 3 Still, the efficient markets hypothesis seems to provide a reason against the occurrence of delayed responses to shocks: In (semi-)strongly efficient markets, all (publicly available) information are reflected in current prices (see Fama (1969) ). Thus, markets would react immediately to the information about shock events. However, not all information about the (own) exposure to shock events may be available immediately, such that a proper market reaction may be delayed. This idea is similarly to the concept of 1 In this article we solely focus on contagion and spillover effects of adverse effects, which is in contrast to other articles incorporating both positive and negative spillovers (for example see International Monetary Fund (2016) and references therein). 2 Harrington (2009) finds that the economics literature mainly distinguishes between four sources of systemic risk: asset price contagion, counterparty contagion, contagion due to uncertainty and opacity of information, and irrational contagion. Another classification is given by Arregui et al. (2013) , who differentiate between contagion caused by direct bilateral exposure across institutions and contagion caused by indirect exposure to common risk factors. Vital features of systemic crises are also described by Marshall (1998) . 3 This effect is often referred to as domino or cascade effect (for example see Committee on Capital Markets Regulation (2009) or Smaga (2014) ).
doi:10.2139/ssrn.2782429 fatcat:h5xvwqq7xrf53i54shuu45kzt4