Measuring the probability of a financial crisis

Robert Engle and Tianyue Ruan

Proceedings of the National Academy of Sciences, 2019, vol. 116, issue 37, 18341-18346

Abstract: When financial firms are undercapitalized, they are vulnerable to external shocks. The natural response to such vulnerability is to reduce leverage, and this can endogenously start a financial crisis. Excessive credit growth, the main cause of financial crises, is reflected in the undercapitalization of the financial sector. Market-based measures of systemic risk such as SRISK, which stands for systemic risk, enable monitoring how such weakness emerges and progresses in real time. In this paper, we develop quantitative estimates of the level of systemic risk in the financial sector that precipitates a financial crisis. Common approaches to reduce leverage correspond to specific scaling of systemic risk measures. In an econometric framework that recognizes financial crises represent left tail events for the economy, we estimate the relationship between SRISK and the financial crisis severity for 23 developed countries. We develop a probability of crisis measure and an SRISK capacity measure based on our estimates. Our analysis highlights the important global externality whereby the risk of a crisis in one country is strongly influenced by the undercapitalization of the rest of the world.

Keywords: financial stability; systemic risk; probability of crisis (search for similar items in EconPapers)
Date: 2019
References: Add references at CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://www.pnas.org/content/116/37/18341.full (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nas:journl:v:116:y:2019:p:18341-18346

Access Statistics for this article

More articles in Proceedings of the National Academy of Sciences from Proceedings of the National Academy of Sciences
Bibliographic data for series maintained by PNAS Product Team ().