Systemic Risk MES Analysis Page
Options
Users may select values for the following options and see the effect on SRISK:
- Crisis Threshold: We define a systemic crisis as occurring when the broad market index falls by more than the crisis threshold in a six-month period. The default crisis threshold is 40%. The default choice reflects the approximate market decline seen during the financial crisis of 2007-2009. Users may change the crisis threshold by entering a value into the spinner above the SRISK Graph.
- Prudential Capital Requirement (k): The prudential capital requirement is the amount of capital, expressed as a share of assets, that a firm would need to weather a financial crisis. Typically, well managed large financial institutions in normal times maintain a capital ratio of 8%. Users may change the prudential capital requirements by entering values in the spinners in the Capital Req section of the options side bar.
- Percentage of Separate Accounts to Include: Insurance companies, especially life insurance companies, have important accounting characteristics that require SRISK adjustments. In these companies, premiums are accumulated in investment funds such as variable annuities. These can be withdrawn often with penalties, and have payouts often at guaranteed levels. These are reported in separate accounts, which appear as both assets and liabilities on the balance sheet. For insurance companies in calm times, typical capital ratios come to about 8% when 40% of separate accounts are included. This matches the default prudential capital requirement for other financial firms. Hence, the default percentage of separate accounts that is included in total liabilities is 40%. Users may change the percentage of Separate Accounts that is included by entering a value in the spinner in the separate accounts section of the options side bar.
SRISK Graph
The SRISK Graph displays a plot of the SRISK series for a given firm. Users may select a firm from the Systemic Risk Rankings Table below the SRISK Graph. Users may also select a different series type to display from the Series drop down menu.
Systemic Risk Rankings Table
The Systemic Risk Rankings Table displays:
- SRISK is the expected capital shortfall of a financial firm in a systemic crisis where the broad market index falls by more than 40% in a six-month period. A financial firm will be unable to function when the value of its equity falls to a sufficiently small fraction of its outstanding liabilities. In good times, such a firm will likely be acquired, may be able to raise new capital or may face an orderly bankruptcy. If this capital shortage occurs at a time when the financial sector is already financially constrained, then the government faces the question of whether to rescue the firm with taxpayer money as other avenues are no longer available. In the theoretical analysis of Acharya, Pederson, Phillipon and Richardson (2010), such a capital shortage is damaging to the real economy as the failure of this firm will have repercussions throughout the financial and real sectors. Consequently a firm is systemically risky if it is likely to face a capital shortage just when the financial sector itself is weak. This systemic risk measure,SRISK, is calculated as k*Debt-(1-k)*(1-LRMES)*MV, where LRMES, the expected fractional loss of the equity when the S&P 500 Index falls by the crisis threshold (default is 40%) in a six-month period. The prudential capital requirement k is set to be 8%. The user can adjust the crisis threshold and/or the prudential capital requirement in the side bar to see the effect on SRISK.
- SRISK% is the proportional contribution of each firm'sSRISK to the total positive SRISK of the financial system.
- Marginal SRISK is the difference in SRISK with the currently-selected market decline and SRISK with a 0% market decline.
- LRMES, or Long-Run Marginal Expected Shortfall, is the expected fractional loss of the firm equity when the S&P 500 Index declines significantly in a six-month period. It is calculated as 1-exp(log(1-d)*beta), where d is the six-month crisis threshold for the market index decline and its default value is 40%; and beta is the firm's CAPM beta. The user can adjust the crisis threshold by a 5% increment in the side bar to see the effect on LRMES.
- Beta is the CAPM Beta of the firm with respect to the S&P 500 Index.
- Cor is the dynamic conditional correlation between the equity return on a stock and the return on the S&P 500 Index. It is estimated with a DCC model that is updated daily.
- Vol is the annualized volatility of the equity of the company. It is estimated with a GJR-GARCH model that is updated daily.
- Lvg is the Quasi Leverage of a company which is 1 plus its book value of liabilities divided by its market value of equity. For those firms with separate accounts, liabilities are reduced by the proportion of separate accounts to include in theSRISK calculation. See the Options section for more details on how separate accounts are used in the calculation of SRISK and how to change the amount included in the calculation.
- Stressed Lvg is the forecasted Quasi Leverage of a company during a crisis. It is defined as:For those firms with separate accounts, liabilities are reduced by the proportion of separate accounts to include in theSRISK calculation. See the Options section for more details on how crisis thresholds and separate accounts are used in the calculation of SRISK and how to change the amount included in the calculation.