XXV Edition

1-2 December 2016"

Financial Companies' Failures: Early Warning Information from Systematic and Systemic Risk Measures

Giannozzi Alessandro, University of Florence
Roggi Oliviero, University of Florence
Cipollini Fabrizio, University of Florence
Menchetti Fiammetta, University of Florence

Following the 2007-2008 financial crisis, advanced risk measures were proposed with the specific aim of quantifying systemic risk, since the existing systematic (market) risk measures were deemed inadequate to signal the collapse of an entire financial system. The paper aims at comparing the systemic risk measures and the earlier market risk measures considering their predictive ability toward the failure of financial companies. Focusing on the 2007-2008 period and considering 28 large US financial companies (among which nine defaulted in the period), four systematic and four systemic risk measures are used to rank the companies according to their risk and to estimate their relationship with the company's failure through a survival Cox model. We found that the two groups of risk measures achieve similar scores in the ranking exercise, and that both show a significant effect on the time-to-default of the financial institutions. This last result is confirmed when the Cox model uses as covariates the risk measures evaluated one, three and six months before the default event. Considering this last case,the most predictive risk measures about the default risk of financial institutions were the Expected Shortfall, the Value-at-Risk, the CAPM Beta and the Systemic Expected Shortfall. We contribute to the literature in two ways. We provide a way to compare risk measures based on their predictive ability toward an event, the company's failure, that is the most catastrophic event for a company. The survival model approach allows to map each risk measure in terms of probability of default over a given time horizon. We note, finally, that although focused on the Great Recession, the analysis could be applied to different periods.

Area: Financial Stability

Keywords: Systemic risk, Regression Beta, Dynamic Conditional Beta, Value-at-Risk, Expected Shortfall, Marginal Expected Shortfall, Systemic Expected Shortfall, SRISK, CoVaR, Cox Proportional Hazard Model

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