Measuring Systemic Financial Stress and its Risks for Growth
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chavleishvili2023 - p. 2
Systemic risk can be characterised as the risk that financial instability becomes so widespread that it severely disrupts the provision of financial services to the broader economy, with significant adverse effects on growth and employment. Financial stress indices quantify the aggregate level of stress in the financial system by compressing a certain number of stress indicators from individual financial market segments into a single statistic. We consider systemic stress as realised systemic risk, and thus as a measure of the severity of financial crises. Our statistical framework defines systemic stress as a state of the financial system in which a representative set of individual stress measures is considered to be extremely high and strongly co-dependent.
chavleishvili2023 - p. 12
Definition 1 (Systemic Financial Stress). Systemic financial stress is a state of the financial system in which stress factors zi,t are generally extremely high (extremeness) and strongly codependent (co-dependence).
chavleishvili2023 - p. 13
hese market segments include: (i) equity markets for nonfinancial corporations; (ii) equity markets for financial institutions (listed banks and other traded financial entities); (iii) money markets (interbank, commercial paper and Tbill markets); (iv) sovereign and corporate bond markets; and (v) foreign exchange markets.
chavleishvili2023 - p. 19
The formula is well-known in finance and describes how to compute the return variance (risk) of a portfolio of assets from the return variances and covariances of a set of assets with equal portfolio shares (see, e.g., the seminal paper on portfolio selection by Markowitz (1952))
chavleishvili2023 - p. 26
Such asymmetric responses of economic activity to financial distress may reflect several mechanisms put forward in the recent theoretical macrofinance literature. For example, the effects of sharply rising financial frictions and increasing uncertainty may be amplified by asset fire sales and credit constraints becoming binding (e.g., Bianchi (2011), He and Krishnamurthy (2012), Lorenzoni (2008) and Mendoza (2010)). Indeed, the popular growth-at-risk literature relies on this macro-financial asymmetry as a stylised fact.