Abstract
Systemic importance of a financial institution is measured as the additional tail loss induced into the system when the financial institution falls into distress due to its own structural shocks. The use of a structural approach is step towards addressing a key concern in systemic risk literature, “Is the firm impacting the market, or is the market impacting the firm?” The identification exploits a novel source of restrictions which arise from the common assumption of a dynamic factor model where the factors are constructed from individual firms, akin to the market portfolio used in asset pricing. The structural representation is revealed by accounting for the embedded endogeneity due to simultaneity. “Too-big-to-fail” restrictions are assumed and the data reveals “too-interconnected-to-fail”, thereby incorporating the two key considerations of systemic importance. Over 21,000 firms listed globally are modelled jointly as a system.
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