Risk-Factor Portfolios and Financial Stability

Gus Garita

MPRA Paper from University Library of Munich, Germany

Abstract: This paper defines a risk-stability index (RSI) that takes into account the extreme dependence structure and the conditional probability of joint failure (CPJF) among risk factors in a portfolio. In combination, both the RSI and CPJF provide a valuable tool for analyzing risk from complementary perspectives; thereby allowing the measurement of (i) common distress of risk factors in a portfolio, (ii) distress between specific risk factors, and (iii) distress to a portfolio related to a specific risk factor. With an application to a financial system comprised of 18 banks from around the world, the results herein show that financial stability must be viewed as a continuum, since risk varies from period to period. The risk-stability index indicates that U.S. banks tend to cause the most stress to the global financial system (as defined herein), followed by Asian and European banks. The results also show that Asian banks seem to experience the most persistence of distress, followed by U.S. and European banks. The panel VAR results show that monetary policy should "lean against the wind", since it has a significant effect in reducing the (potential) instability of a financial system.

Keywords: Conditional probability of joint failure; contagion; dependence structure; distress; multivariate extreme value theory; panel VAR; persistence (search for similar items in EconPapers)
JEL-codes: C10 E44 F15 F36 (search for similar items in EconPapers)
Date: 2009-12-11, Revised 2009-12-11
New Economics Papers: this item is included in nep-ban, nep-rmg and nep-sea
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https://mpra.ub.uni-muenchen.de/19611/1/MPRA_paper_19611.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/20366/1/MPRA_paper_20366.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/21249/3/MPRA_paper_21249.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:19611

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