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Tracking Changes in the Intensity of Financial Sector's Systemic Risk

Xisong Jin () and Francisco Nadal De Simone ()

No 102, BCL working papers from Central Bank of Luxembourg

Abstract: This study provides the first available estimates of systemic risk in the financial sector comprising the banking and investment fund industries during 2009Q4­2015Q4. Systemic risk is measured in three forms: as risk common to the financial sector; as contagion within the financial sector and; as the build­up of financial sector's vulnerabilities over time, which may unravel in a disorderly manner. The methodology models the financial sector components' default dependence statistically and captures the time­varying non-linearities and feedback effects typical of financial markets. In addition, the study estimates the common components of the financial sector's default measures and by identifying the macro-financial variables most closely associated with them, it provides useful input into the formulation of macro­prudential policy. The main results suggest that: (1) interdependence in the financial sector decreased in the first three years of the sample, but rose again later coinciding with ECB's references to increased search for yield in the financial sector. (2) Investment funds are a more important source of contagion to banks than the other way round, and this is more the case for European banking groups than for Luxembourg banks. (3) For tracking the growth of vulnerabilities over time, it is better to monitor the most vulnerable part of the financial sector because the common components of systemic risk measures tend to lead these measures.

Keywords: financial stability? macro-prudential policy? banking sector; investment funds; default probability? non-linearities? generalized dynamic factor model? dynamic copulas (search for similar items in EconPapers)
JEL-codes: C1 E5 F3 G1 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-eec, nep-fmk, nep-mac and nep-rmg
Date: 2016-10
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