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Systemic risk and the Fallacy of Composition: Empirical Evidence from Japanese Regional Bank

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  • Naohisa Hirakata

    (Bank of Japan)

  • Yosuke Kido

    (International Monetary Fund)

  • Jie Liang Thum

    (Monetary Authority of Singapore)

Abstract

We examine a sample of Japanese regional banks and explore whether exposure to market risk factors affects systemic risk through banks' portfolio composition or revenue source, using Adrian and Brunnermeier's (2016) CoVaR to proxy for systemic risk. We find that the securities investment and fee- and commission-related activities of Japanese regional banks exert positive and significant effects on systemic risk by generating higher co-movement among banks, even though they reduce standalone bank risk through portfolio diversification. Further, the marginal effect of an increase in common risk factors on systemic risk is larger when other banks are already highly exposed to common risk factors. We interpret the results as suggestive of "fallacy of composition," since the behavior of individual banks could be individually optimal but collectively has an unwelcome systemic effect. Our results have important implications from the macroprudential perspective.

Suggested Citation

  • Naohisa Hirakata & Yosuke Kido & Jie Liang Thum, 2020. "Systemic risk and the Fallacy of Composition: Empirical Evidence from Japanese Regional Bank," International Journal of Central Banking, International Journal of Central Banking, vol. 16(4), pages 293-325, September.
    • Handle: RePEc:ijc:ijcjou:y:2020:q:3:a:7
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    References listed on IDEAS

    as
    1. Hett, Florian & Schmidt, Alexander, 2017. "Bank rescues and bailout expectations: The erosion of market discipline during the financial crisis," Journal of Financial Economics, Elsevier, vol. 126(3), pages 635-651.
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    4. Florian Hett & Alexander Schmidt, 2013. "Bank Bailouts and Market Discipline: How Bailout Expectations Changed During the Financial Crisis," Working Papers 1305, Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz, revised 01 Aug 2013.
    5. Jon Danielsson & Kevin R. James & Marcela Valenzuela & Ilknur Zer, 2016. "Can We Prove a Bank Guilty of Creating Systemic Risk? A Minority Report," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(4), pages 795-812, June.
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    Cited by:

    1. Kakuho Furukawa & Hibiki Ichiue & Yugo Kimura & Noriyuki Shiraki, "undated". "Too-big-to-fail Reforms and Systemic Risk," Bank of Japan Working Paper Series 21-E-1, Bank of Japan.

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    More about this item

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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