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On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms

Author

Listed:
  • Francis X. Diebold

    (University of Pennsylvania and NBER)

  • Kamil Yilmaz

    (Koc University)

Abstract

We propose several connectedness measures built from pieces of variance decompositions, and we argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. We also show that variance decompositions define weighted, directed networks, so that our connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, we track both average and daily time-varying connectedness of major U.S. financial institutions’ stock return volatilities in recent years, including during the financial crisis of 2007-2008.

Suggested Citation

  • Francis X. Diebold & Kamil Yilmaz, 2011. "On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms," Koç University-TUSIAD Economic Research Forum Working Papers 1124, Koc University-TUSIAD Economic Research Forum.
    • Handle: RePEc:koc:wpaper:1124
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Risk measurement; risk management; portfolio allocation; market risk; credit risk; systemic risk; asset markets; degree distribution;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • G2 - Financial Economics - - Financial Institutions and Services

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