Diagnosis of systemic risk and contagion across financial sectors

Sayuj Choudhari and Richard Licheng Zhu

Papers from arXiv.org

Abstract: In normal times, it is assumed that financial institutions operating in non-overlapping sectors have complementary and distinct outcomes, typically reflected in mostly uncorrelated outcomes and asset returns. Such is the reasoning behind common "free lunches" to be had in investing, like diversifying assets across equity and bond sectors. Unfortunately, the recurrence of crises like the Great Financial Crisis of 2007-2008 demonstrate that such convenient assumptions often break down, with dramatic consequences for all financial actors. In hindsight, the emergence of systemic risk (as exemplified by failure in one part of a system spreading to ostensibly unrelated parts of the system) has been explained by narratives such as deregulation and leverage. But can we diagnose and quantify the ongoing emergence of systemic risk in financial systems? In this study, we focus on two previously-documented measures of systemic risk that require only easily available time series data (eg monthly asset returns): cross-correlation and principal component analysis. We apply these tests to daily and monthly returns on hedge fund indexes and broad-based market indexes, and discuss their results. We hope that a frank discussion of these simple, non-parametric measures can help inform legislators, lawmakers, and financial actors of potential crises looming on the horizon.

Date: 2021-01
New Economics Papers: this item is included in nep-cba and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/2101.06585 Latest version (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:arx:papers:2101.06585

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().