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Modeling financial sector joint tail risk in the euro area

Author

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  • Schwaab, Bernd
  • Lucas, André
  • Zhang, Xin

Abstract

We develop a novel high-dimensional non-Gaussian modeling framework to infer measures of conditional and joint default risk for numerous financial sector firms. The model is based on a dynamic Generalized Hyperbolic Skewed-t block-equicorrelation copula with time-varying volatility and dependence parameters that naturally accommodates asymmetries, heavy tails, as well as non-linear and time-varying default dependence. We apply a conditional law of large numbers in this setting to define joint and conditional risk measures that can be evaluated quickly and reliably. We apply the modeling framework to assess the joint risk from multiple defaults in the euro area during the 2008-2012 financial and sovereign debt crisis. We document unprecedented tail risks between 2011-2012, as well as their steep decline following subsequent policy actions. JEL Classification: G21, C32

Suggested Citation

  • Schwaab, Bernd & Lucas, André & Zhang, Xin, 2015. "Modeling financial sector joint tail risk in the euro area," Working Paper Series 1837, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20151837
    Note: 955417
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    Cited by:

    1. Blasques, Francisco & van Brummelen, Janneke & Koopman, Siem Jan & Lucas, André, 2022. "Maximum likelihood estimation for score-driven models," Journal of Econometrics, Elsevier, vol. 227(2), pages 325-346.
    2. Custodio João, Igor & Lucas, André & Schaumburg, Julia & Schwaab, Bernd, 2023. "Dynamic clustering of multivariate panel data," Journal of Econometrics, Elsevier, vol. 237(2).
    3. Gagnon, Marie-Hélène & Power, Gabriel J. & Toupin, Dominique, 2016. "International stock market cointegration under the risk-neutral measure," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 243-255.
    4. Zheng, Tingguo & Ye, Shiqi & Hong, Yongmiao, 2023. "Fast estimation of a large TVP-VAR model with score-driven volatilities," Journal of Economic Dynamics and Control, Elsevier, vol. 157(C).
    5. Caballero, Diego & Lucas, André & Schwaab, Bernd & Zhang, Xin, 2020. "Risk endogeneity at the lender/investor-of-last-resort," Journal of Monetary Economics, Elsevier, vol. 116(C), pages 283-297.
    6. Kurose, Yuta & Omori, Yasuhiro, 2020. "Multiple-block dynamic equicorrelations with realized measures, leverage and endogeneity," Econometrics and Statistics, Elsevier, vol. 13(C), pages 46-68.
    7. Yuta Kurose & Yasuhiro Omori, "undated". "Multiple-lock Dynamic Equicorrelations with Realized Measures, Leverage and Endogeneity," CIRJE F-Series CIRJE-F-1075, CIRJE, Faculty of Economics, University of Tokyo.
    8. Catania, Leopoldo & Grassi, Stefano, 2022. "Forecasting cryptocurrency volatility," International Journal of Forecasting, Elsevier, vol. 38(3), pages 878-894.
    9. Francisco (F.) Blasques & Andre (A.) Lucas & Andries van Vlodrop, 2017. "Finite Sample Optimality of Score-Driven Volatility Models," Tinbergen Institute Discussion Papers 17-111/III, Tinbergen Institute.
    10. Yuta Kurose & Yasuhiro Omori, 2016. "Multiple-block Dynamic Equicorrelations with Realized Measures, Leverage and Endogeneity," CIRJE F-Series CIRJE-F-1024, CIRJE, Faculty of Economics, University of Tokyo.
    11. Fuentes, Fernanda & Herrera, Rodrigo & Clements, Adam, 2023. "Forecasting extreme financial risk: A score-driven approach," International Journal of Forecasting, Elsevier, vol. 39(2), pages 720-735.
    12. Anne Opschoor & André Lucas & István Barra & Dick van Dijk, 2021. "Closed-Form Multi-Factor Copula Models With Observation-Driven Dynamic Factor Loadings," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 39(4), pages 1066-1079, October.
    13. Stephen Thiele, 2020. "Modeling the conditional distribution of financial returns with asymmetric tails," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 35(1), pages 46-60, January.
    14. Linda Mhalla & Julien Hambuckers & Marie Lambert, 2022. "Extremal connectedness of hedge funds," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 37(5), pages 988-1009, August.
    15. Blasques, Francisco & Lucas, André & van Vlodrop, Andries C., 2021. "Finite Sample Optimality of Score-Driven Volatility Models: Some Monte Carlo Evidence," Econometrics and Statistics, Elsevier, vol. 19(C), pages 47-57.
    16. Lin Deng & Michael Stanley Smith & Worapree Maneesoonthorn, 2023. "Large Skew-t Copula Models and Asymmetric Dependence in Intraday Equity Returns," Papers 2308.05564, arXiv.org, revised Jul 2024.

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    More about this item

    Keywords

    dynamic equicorrelation; generalized hyperbolic distribution; large portfolio approximation; law of large numbers;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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