Tracking Variation in Systemic Risk at US Banks During 1974-2013

Armen Hovakimian, Edward Kane and Luc Laeven
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Armen Hovakimian: Baruch College

No 16, Working Papers Series from Institute for New Economic Thinking

Abstract: This paper proposes a theoretically based and easy-to-implement way to measure the systemic risk of financial institutions using publicly available accounting and stock market data. The measure models the credit enhancement taxpayers provide to individual banks in the Merton tradition (1974) as a combination put option for the deep tail of bank losses and a knock-in stop-loss call on bank assets. This model expresses the value of taxpayer loss exposure from a string of defaults as the value of this combination option written on the portfolio of industry assets. The exercise price of the call is the face value of the debt of the entire sector. We conceive of an individual bank’s systemic risk as its contribution to the value of this sectorwide option on the financial safety net. To the extent that authorities are slow to see bank losses or reluctant to exercise the call, the government itself becomes a secondary source of systemic risk. We apply our model to quarterly data over the period 1974-2013. The model indicates that systemic risk reached unprecedented highs during the financial crisis years 2008- 2009, and that bank size, leverage, and asset risk are key drivers of systemic risk.

JEL-codes: G01 G28 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2015-08
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-pke and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Working Paper: Tracking Variation in Systemic Risk at US Banks During 1974-2013 (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:16

DOI: 10.2139/ssrn.2642852

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