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A Framework for Assessing the Systemic Risk of Major Financial Institutions

Xin Huang, Hao Zhou () and Haibin Zhu

No 281, BIS Working Papers from Bank for International Settlements

Abstract: In this paper we propose a framework for measuring and stress testing the systemic risk of a group of major financial institutions. The systemic risk is measured by the price of insurance against financial distress, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations. Importantly, using realized correlations estimated from high-frequency equity return data can significantly improve the accuracy of forecasted correlations. Our stress testing methodology, using an integrated micro-macro model, takes into account dynamic linkages between the health of major US banks and macro-financial conditions. Our results suggest that the theoretical insurance premium that would be charged to protect against losses that equal or exceed 15 % of total liabilities of 12 major US financial firms stood at $110 billion in March 2008 and had a projected upper bound of $250 billion in July 2008.

Keywords: systemic risk; stress testing; portfolio credit risk; credit default swap; high-frequency data (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-mst and nep-rmg
Date: 2009-04
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Related works:
Journal Article: A framework for assessing the systemic risk of major financial institutions (2009) Downloads
Working Paper: A framework for assessing the systemic risk of major financial institutions (2009) Downloads
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