Measuring the probability of a financial crisis.

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ID: 41577
2019
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Ranked #160 of 292 articles by views in Proceedings of the National Academy of Sciences of the United States of America

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Abstract
When financial firms are undercapitalized, they are vulnerable to external shocks. The natural response to such vulnerability is to reduce leverage, and this can endogenously start a financial crisis. Excessive credit growth, the main cause of financial crises, is reflected in the undercapitalization of the financial sector. Market-based measures of systemic risk such as SRISK, which stands for systemic risk, enable monitoring how such weakness emerges and progresses in real time. In this paper, we develop quantitative estimates of the level of systemic risk in the financial sector that precipitates a financial crisis. Common approaches to reduce leverage correspond to specific scaling of systemic risk measures. In an econometric framework that recognizes financial crises represent left tail events for the economy, we estimate the relationship between SRISK and the financial crisis severity for 23 developed countries. We develop a probability of crisis measure and an SRISK capacity measure based on our estimates. Our analysis highlights the important global externality whereby the risk of a crisis in one country is strongly influenced by the undercapitalization of the rest of the world.
Reference Key
engle2019measuringproceedings Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Engle, Robert F;Ruan, Tianyue;
Journal Proceedings of the National Academy of Sciences of the United States of America
Year 2019
DOI
201903879
URL
Keywords Keywords not found

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