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Measuring Systemic Risk: Common Factor Exposures and Tail Dependence Effects
Author(s) -
Chiu WanChien,
Peña Juan Ignacio,
Wang ChihWei
Publication year - 2015
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/eufm.12040
Subject(s) - systemic risk , econometrics , tail dependence , economics , tail risk , factor analysis , risk factor , stock (firearms) , financial market , index (typography) , stock market , financial economics , financial crisis , statistics , mathematics , finance , biology , computer science , macroeconomics , medicine , geography , multivariate statistics , paleontology , archaeology , horse , world wide web
We model systemic risk using a common factor that accounts for market‐wide shocks and a tail dependence factor that accounts for linkages among extreme stock returns. Specifically, our theoretical model allows for firm‐specific impacts of infrequent and extreme events. Using data on the four sectors of the US financial industry from 1996 to 2011, we uncover two key empirical findings. First, disregarding the effect of the tail dependence factor leads to a downward bias in the measurement of systemic risk, especially during weak economic times. Second, when these measures serve as leading indicators of the St. Louis Fed Financial Stress Index, measures that include a tail dependence factor offer better forecasting ability than measures based on a common factor only.