Abstract
For the first time, this study evaluates the contributions to systemic risk in the context of U.S. institutional prime money market funds (MMFs) from different sources using partial least squares structural equation modeling (PLS-SEM). The primary motivation behind this study is to trace systemic risk to its underlying sources and measure which types of relationships provide significant explanation using PLS-SEM. I illustrate the application of PLS-SEM and interpretation of results in a step-by-step manner to empower those new to PLS-SEM, and undertake robustness testing. Findings indicate that through crisis years, macroprudential indicators contribute to potential systemic risk more than prudential indicators. This suggests that macroprudential indicators that can be traced to individual MMFs market positions are more important in understanding systemic risk during crises, and further underlines the interconnectedness of markets. PLS-SEM can be used to test the explanatory power of new indicators as they emerge in an exploratory environment.
Highlights
As a tighter regulation of non-bank financial institutions (NbFIs) unfolds, following the global financial crisis (GFC) of 2007-2009, there is a need to monitor creation of systemic risk with new versatile tools of analysis that help explain the role of different sources of systemic risk
This study evaluates the contribution of each category of sources of systemic risk observed in money market funds (MMFs) using partial least squares structural equation modeling (PLS-SEM) in an effort to help regulators, managers of MMFs and investors better monitor the market
This study evaluates the contribution of each category of sources of systemic risk with the aim of helping regulators, managers of MMFs and investors better monitor the market
Summary
As a tighter regulation of non-bank financial institutions (NbFIs) unfolds, following the global financial crisis (GFC) of 2007-2009, there is a need to monitor creation of systemic risk with new versatile tools of analysis that help explain the role of different sources of systemic risk. These are: 1) systemic risk sourced from within MMFs (prudential perspective), and 2) systemic risk sourced from MMFs’ market positions (macroprudential perspective). I note that macroprudential policies are increasingly gaining priority in reforming regulation of the financial system because the Basel III Accord is inadequate in addressing spillovers into the less regulated shadow banking sector where NbFIs exist [2]
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