Abstract
This paper develops a simple method for quantifying banks’ exposures to large (negative) shocks in a forward-looking manner. The method is based on estimating banks’ share prices sensitivities to (market) put options and does not require the actual observation of tail risk events. We find that estimated (excess) tail risk exposures for U.S. Bank Holding Companies are negatively correlated with their share price beta, suggesting that banks which appear safer in normal periods are actually more crisis prone than their beta would suggest. We also study the determinants of banks’ tail risk exposures and find that their key drivers are uninsured deposits and non-traditional activities that leave assets on banks’ balance sheets.
Highlights
A systemic banking crisis—a situation in which many banks are in distress at the same time—can induce large costs for the economy
We focus on U.S Bank Holding Companies (BHCs) which are classified as commercial banks and for which data is fully available
We focus on the BHC instead of the commercial bank itself, as typically it is the BHC that is listed on the stock exchange
Summary
A systemic banking crisis—a situation in which many banks are in distress at the same time—can induce large costs for the economy. We define a bank’s (systemic) tail risk as its exposure to a large negative market shock We measure this exposure by estimating a bank’s share price sensitivity to changes in far out-of-the-money put options on the market, correcting for market movements themselves. As this sensitivity reflects perceived exposures to a hypothetical crash, it is truly forward-looking in nature This property is important to the extent that bank risks change quickly and historical tail risk exposures become less informative. We use our methodology to understand the main drivers of bank tail risk Understanding these drivers is important for regulators as it gives them information about which activities should be encouraged and which not.
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