A connectedness analysis of German financial institutions during the financial crisis in 2008

Abstract

For core financial market activities like risk management and asset pricing, it appears to be crucial to investigate the “connectedness” among financial institutions. In times of economic crises, a suitable measure of connectedness can provide valuable insights of financial markets and helps to understand how institutions influence each other. In particular, depending on contractual obligations between financial institutions, the financial distress at a bank with large systemic impact is likely to cause also distress at other institutions. In the literature, the latter phenomenon is generally tagged by ’contagion’ and can eventually result in severe economic crises. The purpose of this paper is to investigate the connectedness among German financial institutions during the global financial crisis 2007-2009, where the authors focus particularly on 2008 and its height in September 2008 with the bankruptcy of Lehman Brothers. They make use of the definition of connectedness, as it was recently proposed by Diebold and Yilmaz (2014). Their approach relies on analyzing multiple time series of volatilities by a vector autoregressive (VAR) model and a generalized forecast error variance decompositions. It provides several meaningful measures of connectedness and allows for static (average), as well as dynamic (daily time-varying) analyses. The authors show that the connectedness in Germany can be described well by the model. Keywords: сonnectedness, contagion, generalized variance decomposition, networks, spillover effects. JEL Classification: C32, C58, G32, G33