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Systemic Risk Indicators Based on Nonlinear PolyModel

Xingxing Ye () and Raphael Douady ()
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Xingxing Ye: Department of Applied Mathematics and Statistics, State University of New York at Stony Brook, Stony Brook, NY 11794-3600, USA

Journal of Risk and Financial Management, 2018, vol. 12, issue 1, 1-24

Abstract: The global financial market has become extremely interconnected as it demonstrates strong nonlinear contagion in times of crisis. As a result, it is necessary to measure financial systemic risk in a comprehensive and nonlinear approach. By establishing a large set of risk factors as the main bones of the financial market network and applying nonlinear factor analysis in the form of so-called PolyModel, this paper proposes two systemic risk indicators that can prognosticate the advent and trace the development of financial crises. Through financial network analysis, theoretical simulation, empirical data analysis and final validation, we argue that the indicators suggested in this paper are proved to be very effective in forecasting and tracing the financial crises from 1998 to 2017. The economic benefit of the indicator is evidenced by the enhancement of a protective put/covered call strategy on major stock markets.

Keywords: systemic risk crisis; financial indicator; network; nonlinear regression; PolyModel; validation (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2018
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