Spillover effects among financial institutions within Germany and the United Kingdom

Abstract

The recent financial crisis has shown that the relatively new interconnectedness of different types of institutions leads to a transmission of risk between them, therefore increasing systemic risk. This study investigates whether and to what extent financial institutions in Germany and the United Kingdom are exposed to risk transmission. To achieve this, a state-dependent sensitivity value at risk approach is chosen. The empirical estimates suggest that hedge funds are the predominant source of risk spillovers, both in Germany and the UK, while they themselves receive very little risk spillovers. For the United Kingdom, it is shown that the magnitude of risk transmission is similar to that observed for Germany. However, UK insurance firms are less prone to spillovers from the hedge fund industry, but more affected by risks transmitted from banks, indicating possible implications for policy making. Overall, the increase in risk spillovers in volatile times is striking and suggests adapting future regulation to account for this phenomenon.