Structured factor copulas for modeling the systemic risk of European and United States banks

Hoang Nguyen, Audron\.e Virbickait\.e, M. Concepci\'on Aus\'in and Pedro Galeano

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Abstract: In this paper, we employ Credit Default Swaps (CDS) to model the joint and conditional distress probabilities of banks in Europe and the U.S. using factor copulas. We propose multi-factor, structured factor, and factor-vine models where the banks in the sample are clustered according to their geographic location. We find that within each region, the co-dependence between banks is best described using both, systematic and idiosyncratic, financial contagion channels. However, if we consider the banking system as a whole, then the systematic contagion channel prevails, meaning that the distress probabilities are driven by a latent global factor and region-specific factors. In all cases, the co-dependence structure of bank CDS spreads is highly correlated in the tail. The out-of-sample forecasts of several measures of systematic risk allow us to identify the periods of distress in the banking sector over the recent years including the COVID-19 pandemic, the interest rate hikes in 2022, and the banking crisis in 2023.

Date: 2024-01
New Economics Papers: this item is included in nep-ban, nep-fdg and nep-rmg
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Journal Article: Structured factor copulas for modeling the systemic risk of European and United States banks (2024)
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