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System-wide risk and systemic importance: an incomplete review of metrics and data

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Systemic Risk: Mathematical Modelling and Interdisciplinary Approaches

I. Two major competing types of systemic-risk metrics are: (i) quantiles, e.g. VaR; and (ii) tail expectations, e.g. expected shortfall (ES). I.a. The choice of a risk metric is often motivated with: (i) properties of the metrics estimator; (ii) computational convenience. But different metrics correspond to different economic concepts and thus to different policy objectives (e.g. to reduce system-wide risk vs. to build a war chest for a systemic crisis). Similar tension between alternative metrics exists in an investment portfolio context.

I.b. Given a metric for system-wide risk, the Shapley value offers a convenient prism for comparing alternative measures of the systemic importance of individual institutions. It also allows for deriving important properties of these measures and for identifying the policy contexts in which they should be used.

I.c. There is a subtle difference between the impact of an institution on system-wide risk and the presence of an institution in systemic events. Ignoring this difference could lead to grossly misleading conclusions as regards systemic importance.

II. Data availability shapes existing approaches to measuring system-wide risk and systemic importance. One approach builds on a structural model of system-wide risk and relies on balance sheet data and commercial vendors estimates of individual riskiness. Another approach builds on reduced-form models and relies on market-price data.

II.a. The first approach has revealed a material impact of the system’s network structure on system-wide risk and the systemic importance of individual institutions. The scarcity of real-world data on such structures is thus a major problem in practical applications. II.b. The second approach makes it possible to study tail interdependence across institutions. Tools based on extreme-value theory deliver estimates of such interdependence, which contributes materially to measures of systemic importance.

Related Links: http://www.sciencedirect.com/science/article/pii/S1042957313000326 – “Measuring the systemic importance of interconnected banks” http://www.bis.org/publ/work308.htm – “Attributing systemic risk to individual institutions” http://www.bis.org/publ/qtrpdf/r_qt1306g.htm – “Looking at the tail: price-based measures of systemic importance”

This talk is part of the Isaac Newton Institute Seminar Series series.

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