Modelling systemic risk in financial markets

Abstract

This dissertation provides a study on systemic risk in financial markets; it is laid out as follows. Chapter 1 provides a survey of the quantitative measure of systemic risk in the economics and finance literature. In Chapter 2 examine, using conditional VaR (CoVaR), the systemic risk generated by major Spanish financial institutions in the recent global financial crisis and the European sovereign debt crisis as a systemic risk measure. CoVaR was quantified using quantile regression, multivariate generalized autoregressive conditional heteroskedasticity (MGARCH) and copula approaches. We also describe a novel copula-based approach to computing the CoVaR value, given that copula are flexible modellers of joint distribution and are particularly useful for characterizing the tail behaviour that provides such crucial information for the CoVaR. We found significant increases in systemic risk around the time of the recent global financial crisis and, to a lesser extent, around the time of the European debt crisis. Our evidence also shows that the quantile regression approach was unable to reflect the dynamics of, and sudden changes in, systemic risk. These results have implications for capital regulation in financial institutions and on how systemic risk should be measured. In chapter 3 we study systemic risk in European sovereign debt markets before and after the onset of the Greek debt crisis, taking, as a systemic risk measure, the CoVaR as characterized and computed using copulas. We found sovereign debt markets to be coupled before the debt crisis and systemic risk to be similar for all countries. With the onset of the Greek crisis, debt markets decoupled and the systemic risk of the countries in crisis (excepting Spain) decreased whereas that of the non-crisis countries increased slightly. The systemic risk of the Greek debt market increased for other countries in crisis, especially for Portugal (where systemic risk tripled after the onset of the crisis) and decreased for non-crisis countries. In Chapter 4 we investigated - using the CoVaR measure as characterized and computed using copulas and vine copulas - systemic sovereign debt distress in European domestic financial systems and the systemic risk of a potentially distressed Greek debt market for other European financial systems countries before and after the onset of the recent financial and debt crises. We found that, before the debt crisis, sovereign debt had a positive systemic risk on European domestic financial systems. However, with the onset of the Greek crisis, the systemic impact of sovereign debt increased for countries in crisis (Greece, Italy and Portugal) whereas it remained stable or reduced for non-crisis countries. Regarding the systemic impact of sovereign Greek debt distress, our evidence indicates that negative impacts were limited to a small set of countries (Belgium, Italy, the Netherlands and Portugal).