Abstract
This paper investigates the extent of vulnerability in the U.S. commercial banking system through a pro-cyclical interaction between the market-wide risk perception and system-wide asset management behavior. Based on a Markov regime-switching model, the proposed diagnostic framework clearly illustrates its ability to provide an early warning signal of the build-up and unwinding of fragility in the financial system and the real economy for a counter-cyclical structure of regulatory policy. Empirical results demonstrate an asset pricing implication, as the proposed systemic bubble index is a significant factor that affects the investment opportunity set of stock investors for financial firms but not for non-financial firms.
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