Project of thesis

Subject: Systemic risk measures, banking supervision and financial stability.

Content:

The financial crisis that unfolded in September 2008 transformed the United States and world economies. During times of financial crisis, losses tend to spread across financial institutions, threatening the financial system as a whole. The common measure of risk used by financial institution is the Value at Risk (VaR), which focuses on the risk of an individual institution in isolation. The a %[1]-VaR is the maximum dollar loss within the 1-a % confidence interval. However, such a measure of a single institution’s risk does not necessarily reflect the risk that the stability of the financial system as a whole is threatened. For the future research, the development of such a risk measure-CoVar[2] should identify the risk on system by “individually systemic” institutions, which are massively interconnected, but also by institutions which are “systemic as a tribute”. For example Goldman Sachs could affect JP Morgan as individual institutions, and investment bank sector could affect insurance company sector as a systemic institutions. Then we could argue the regulatory requirements that based on the delta CoVar[3], capturing an institution’s (marginal) contribution to systemic risk. Countercyclical regulation should take into account institutions’ characteristics such as leverage, maturity mismatch and size that predict systemic risk contributions.

Economics is a quantitative science[4]. However, there is no such widely accepted measure, quantification, or time series for measuring either financial or banking stability. While much useful research has been done employing a crisis on/off dichotomy, it has several inherent deficiencies. In particular, the lack of a continuous scale makes it impossible to measure with sufficiently accuracy either (i) the relative riskiness of the system in non-crisis mode, or (ii) the intensity of a crisis, once it has started. If the former could be measured, it may be easier to take early remedial action as the danger of systemic crisis increases, while measurement of the latter would facilitate decision making on the most appropriate measures to address the crisis. To overcome these difficulties I will follow the recent research which tells us that for improving the analysis and management of financial (banking) stability is to be able to construct a metric for it therefore to provide a method for estimating a set of stability measures of banking system (BSMs). This approach defines the banking system as a portfolio of banks and infers the system’s multivariate density (BSMD) from which the proposed measures are estimated. The BSMD embeds the banks’ default inter-dependence structure that captures linear and non-linear distress dependencies among the banks in the system, and its changes at different times of the economic cycle.

Although the fall in US property prices is the fundamental cause of the crisis was widely predicted, the effect that this had on financial institutions and market were not. In particular, what has perhaps been most surprising is the role that liquidity has played in the current crisis.

[1] Normally 5%.

[2] The Value at Risk (VaR) of the financial system conditional on institutions being under distress.

[3] The difference between CoVaR and the financial system VaR

[4] Macroeconomics depends on data for national income, expenditure and output variables. Microeconomics is based on data for prices and quantities of inputs and outputs.