Abstract

This paper analyzes the relationship between derivative usage and systemic risk in South Africa. We employ expected shortfall as a measure of systemic risk for the banking sector. The more flexible Toda-Yamamoto Granger non-causality test is used to find the direction of causality between the variables, and the ARDL estimation technique is employed to estimate the specified model. We also test for the existence of a long-run relationship amongst the variables using the Bounds test approach. We find that credit derivatives and bank credit extensions increase systemic risk in the long run. Moreover, the systemic risk decreases in bank liquidity and usage of equity derivatives. However, in the short run, we find that increases in bank liquidity tend to increase systemic risk. We interpret this to imply that improvements in liquidity cause banks to undertake riskier transactions. Furthermore, the market can also perceive central bank interventions to increase liquidity as a sign of worsening financial conditions. On the backdrop of these results, we recommend continuous monitoring of derivatives markets to avoid risk excesses that could pose threat to the whole financial system.

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