Systemic Risk Contagion Research Articles

The Stability of Interbank Market Network: A Perspective on Contagion and Risk Sharing

As an important part of the financial system, interbank market provides banks with liquidity and credit lending and also is the main channel for risk contagion. In this paper, we test the existence of systematic risk contagion within the Chinese interbank market. By building the networks of the Chinese interbank market for each year and using the measure of mutual information, we quantitatively detect the changes of interbank market networks and observe that the correlations between banks become increasingly tighter in recent years. With the bilateral risk exposure among Chinese listed commercial banks, we find that the possibility of systemic risk contagion in Chinese interbank market is fairly small. But of great concern on each individual bank, the matter is different. Our simulation shows that the failures of three special banks (i.e., Agricultural Bank of China and Bank of China and Industrial and Commercial Bank of China) most likely lead to systemic risk contagion. Furthermore, we test the antirisk ability of the Chinese interbank market from the perspective of risk sharing and discover that the interbank market is stable when the loss scale is lower than forty percent of banks’ total core capital.

The Role of Finance in Promoting Sustainable Development

The actual financial crisis put the emphasis in the study of the financial market structure to avoid the international contagion risk or systemic risk. The development of new financial instruments are necessary and the financial innovation is important to promoting the economic growth. In order to design a sustainable finance system it is necessary the consideration of economic fundamentals together with the classical legal figures, because those concepts have the historical data that we could use and put together to promoting sustainable development. In a globalized economic system the design of new financial product must be build up with the development of strong fiscal policies. We can’t ignore that emerging markets in modern times are explained, in part, by the greater similarity between the economic structures in many countries. And now, the emerging economies are better diversified and they engaged in more similar economic activities than they did in the past. The source of systemic risk today is not necessarily the source of systemic risk in the future. The increase in interbank connectivity creates more opportunities for financial development, but as the same time creates more opportunities for systemic risk contagion and transmission in the future.

Systemic Risk and Financial Contagion

It is widely acknowledged now, by many financial and macroeconomists, that in the past, only little attention has been paid to “systemic risk” and “financial contagion”. Rochet and Tirole point out that the ”anxiety about systemic risk is perhaps strongest among bank executives and regulators“. Galati and Moessner state that ”there has been a fundamental lack of understanding of system-wide risk“. Battiston et al. confirm the latter statement by saying that the ”recent financial crisis has shown that systemic risk has been dramatically underestimated“. Fouque and Langsam emphasis this fact when they say that the ”[r]ecent history has shown us not only the enormous cost of a systemic crisis but also how woefully unprepared and ill-equipped governments and private markets have been to prevent systemic crisis or minimize its impact“. According to Geanakoplos et al. Macroeconomists were completely surprised by the financial crisis of 2007-2009. Up until then they had concentrated on macroeconomics with a capital M: global imbalances, interest rates, monetary policy“. Therefore, as Martinez-Jaramillo et al. put it, the ”understanding of systemic risk is of central importance for maintaining financial stability“.

Analysis of Financial Services Sector Transparency Through Whistle Blowing: The Case of South Africa and Switzerland

There intimate connections between the 2007-9 financial crisis, ineffective regulation and the scandals that preceded that calamity, have led to rising demands for the re-evaluation and smarter coordination of the financial sector’s governance, supervision and enforcement mechanisms with a view to preventing their recurrences. The calls for changes in the current systems come on the backdrop of the recognition that the financial fiascos cast a shadow over the ability of codes of conduct, traditional supervisory and enforcement strategies to insulate the global financial sector from failure. In essence, demands for a new architecture in the governance of the pilloried sector are embedded in the critical need to re-instil trust and credibility eroded by inter alia, lack of transparency in the sector. Intertwined with human frailties such as, and mainly, untrammelled greed, excessive ‘group think’ and ‘herd behaviour,’ widespread intransparency engendered a fertile ground upon which scandals flourished. Post-crisis diagnostics have arguably steam-rolled into a governance discussion in which the need for transparency and the importance of ethical and moral aspects of economic activities within the financial services have come to the fore. This paper contributes to that discussion by building on the widely recognised fact that whistle blowing is an essential element of the transparency agenda and that it is a core element of a well-functioning risk management system, it seeks to make a contribution to the literature on global economic governance and financial transparency. The paper is a comparative examination of the degree to which Switzerland and South Africa have enhanced the transformative role of transparency through whistle blowing. This is a crucial quest especially in view of the fact that the recent financial crisis highlighted how internationalised the financial sector has become and demonstrated how, in the absence of harmonized policies and standards, the perils of systemic risk and cross border contagion can easily spread through the global village’s fault lines and vulnerabilities.

Hawkes Processes in Finance

In this paper we propose an overview of the recent academic literature devoted to the applications of Hawkes processes in finance. Hawkes processes constitute a particular class of multivariate point processes that has become very popular in empirical high-frequency finance this last decade. After a reminder of the main definitions and properties that characterize Hawkes processes, we review their main empirical applications to address many different problems in high-frequency finance. Because of their great flexibility and versatility, we show that they have been successfully involved in issues as diverse as estimating the volatility at the level of transaction data, estimating the market stability, accounting for systemic risk contagion, devising optimal execution strategies or capturing the dynamics of the full order book.

Network Linkages to Predict Bank Distress

Building on the literature on systemic risk and financial contagion, the paper introduces estimated network linkages into an early-warning model to predict bank distress among European banks. We use multivariate extreme value theory to estimate equity-based tail-dependence networks, whose links proxy for the markets' view of bank interconnectedness in case of elevated financial stress. The paper finds that early warning models including estimated tail-dependencies consistently outperform bank-specific benchmark models without networks. The results are robust to variation in model specification and also hold in relation to simpler benchmarks of contagion. Generally, this paper gives direct support for measures of interconnectedness in early-warning models, and moves toward a unified representation of cyclical and cross-sectional dimensions of systemic risk.

Is there Inter-Regional Systemic Risk Contagion? An Investigation of Inter-Regional Systemic Risk Spillover Effects using the ESS-indicator and Bank CDS Spreads

During the 2007-2009 financial crisis certain events in the American financial system affected financial markets around the globe. Moreover, since the onset of the euro zone sovereign debt crisis, the systemic risk in Europe also appeared to affect the banking sector risk in other regions. While both effects are mentioned frequently in the public discourse on banking sector risk contagion and regulation, a scientific examination of these inter-regional contagion effects is to the best of our knowledge not available. In this paper we fill this gap and analyze the inter-regional systemic risk contagion effects between the regional relative expected systemic shortfall (ESS) indicator and alternatively the regional bank CDS spreads of the American, Asia-Pacific, European as well as the Middle East and Russia sub-samples in Lahmann/Kaserer (2011) by means of Granger-causality tests and impulse response analysis in vector autoregressive frameworks during four sub-periods between October 2005 and April 2011.We find that during the financial crisis period the systemic risk in America leads the systemic risk in other regions and during the euro zone sovereign debt crisis period the impact of the European systemic risk on the banking sectors in other regions is more pronounced. Moreover, additional lead-lag relationships are observed.

Basel II and Extreme Risk Analysis

Basel II mandates the maintenance of bank capital to address three broad categories of risk: credit risk, market risk and operation risk. Basel II methodology assumes that credit risk can be reliably specified with respect to particular asset categories. These projections are based on historical experience, reflected in data sets, which are at times general and at times specific to a particular institution. Basel II may have failed, however, to identify the strong shift in the correlation of defaults that accompanied the financial crisis. Market risk assessment displays similar issues of under-anticipated correlation under extreme conditions. Of the three categories, operational risk is the least tractable. It is a catch-all category, reflecting both internal failures and external events. The character of risk shifts markedly between ‘ordinary times’ and extreme events. Consider this matrix:Credit Risk• In Ordinary Times, defaults may be predicted based on historical data; there is no strong correlation of default.• During Extreme Events, there is often inadequate data for a robust quantification of risk, where there is a strong correlation of default.Market Risk• In Ordinary Times, loss of value is linked to the performance of a particular asset.• During Extreme Events, loss of value is linked to asset type (that is, contagion).Operational Risk• In Ordinary Times, operational losses are more likely to be institution-specific.• During Extreme Events, operational losses originate from the general environment.This paper addresses the ability of Basel II to respond to extreme events. Extreme events include events thought to be extremely unlikely and events that are unimagined (and hence ex ante unimaginable). Basel II largely examines risk as faced by individual financial institutions. Yet systemic risk (contagion) is a well-recognized feature of the international financial system. The liquidity crisis, however, appears to be a novel (unanticipated) phenomenon. Cross-failure of institutions may be yet another example of unanticipated correlation of outcomes, with a peculiar magnification effect. Basel II does not ask – at least not explicitly – whether there is adequate capital across the entire banking system. The current financial crisis may be an instance where this failed to hold. A revised Basel regime might need to account for additional capital stored outside individual institutions to assure adequate capital under extreme conditions affecting the broader banking sector.