Measuring Systemic Risk

Viral V. Acharya, Lasse Heje Pedersen, Thomas Philippon, Matthew P. Richardson

Research output: Working paperResearch

Abstract

We present a simple model of systemic risk and we show that each financial institution's contribution to systemic risk can be measured as its systemic expected shortfall (SES), i.e., its propensity to be undercapitalized when the system as a whole is undercapitalized. SES increases with the institution's leverage and with its expected loss in the tail of the system's loss distribution. Institutions internalize their externality if they are ‘taxed’ based on their SES. We demonstrate empirically the ability of SES to predict emerging risks during the financial crisis of 2007-2009, in particular, (i) the outcome of stress tests performed by regulators; (ii) the decline in equity valuations of large financial firms in the crisis; and, (iii) the widening of their credit default swap spreads.
Original languageEnglish
Place of PublicationLondon
PublisherCentre for Economic Policy Research
Number of pages33
Publication statusPublished - Feb 2012
SeriesCentre for Economic Policy Research. Discussion Papers
Number8824
ISSN0265-8003

Keywords

  • Bailot
  • Financial Regulation
  • System Risk
  • Value at Risk

Cite this

Acharya, V. V., Heje Pedersen, L., Philippon, T., & Richardson, M. P. (2012). Measuring Systemic Risk. Centre for Economic Policy Research. Centre for Economic Policy Research. Discussion Papers, No. 8824 http://esc-web.lib.cbs.dk/login?url=http://www.cepr.org/pubs/dps/DP8824.asp