Abstract
This paper investigates the dynamic evolution of tail risk interdependence among U.S. banks, financial services and insurance sectors. Life and non-life insurers have been considered separately to account for their different characteristics. The tail risk interdependence measurement framework relies on the multivariate Student-t Markov switching (MS) model and the multiple-conditional value-at-risk (CoVaR) (conditional expected shortfall (CoES)) risk measures introduced in Bernardi et al. (2013), accounting for both the stylized facts of financial data and the contemporaneous multiple joint distress events. The Shapley value methodology is then applied to compose the puzzle of individual risk attributions, providing a synthetic measure of tail interdependence. Our empirical investigation finds that banks appear to contribute more to the tail risk evolution of all of the remaining sectors, followed by the financial services and the insurance sectors, showing that the insurance sector significantly contributes as well to the overall risk. We also find that the role of each sector in contributing to other sectors’ distress evolves over time according to the current predominant financial condition, implying different interdependence strength.
Highlights
For a long period of time in most countries, there has been a distinct separation among insurance companies, banks and financial institutions providing diversified financial services, so that events in one sector usually had little or negligible effects on the others
According to the current literature, we apply the Akaike information ceriterion (AIC) and the Bayesian information criterion (BIC), which involve different penalization terms depending on the number of non-redundant parameters
This paper aims to assess the contribution of the different sectors of the financial system to the overall risk and to measure their degree of interdependence
Summary
For a long period of time in most countries, there has been a distinct separation among insurance companies, banks and financial institutions providing diversified financial services, so that events in one sector usually had little or negligible effects on the others. Insurance companies have been investing in corporate bonds and equity, have become proprietaries of mutual funds and have entered the market of investment management by providing structured financial products in direct competition with the banking sector. Banks and financial institutions providing general financial services have engaged in a variety of non-core activities, such as insurance underwriting, traditionally devoted to insurers. The expansion by the insurance corporation American International Group (AIG) of the core activity into the credit default swaps (CDS) market has been highlighted as one of the major causes of its collapse, bailout and quasi-nationalization at the end of September 2008; see, e.g., Harrington [4] and Cummins and
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