Tail Dependence in the US Banking Sector and Measures of Systemic Risk

Abstract

Tail dependence among international stock markets is widely studied using measures of extremal dependence. In this study, we investigate the extremal dependence among stock prices of US bank holding companies. We find they exhibit strong dependence even in their limiting joint extremes. Motivated by this result, we derive extremal dependence-based systemic risk measures. The proposed systemic risk measures capture downturns in US stock markets, and in particular the financial industry, very well. We also develop another set of extremal dependence-based measures to rank financial institutions based on their systemic interconnectedness. By means of regression analysis we show that interconnectedness measures can be used as indicators of vulnerability to financial crisis. Finally, we identify drivers of extremal dependence in the US banking industry. Similarity between banks on key financial variables increases the likelihood of banks being asymptotically dependent, and increases the strength of asymptotic dependence. We believe the proposed measures have the potential to inform the prudential supervision of systemically important firms which is an area of interest to supervisory policy makers.