- Dimitrios Bisias,
- Mark Flood,
- Andrew W. Lo Stavros Valavanis
We provide a survey of 31 quantitative measures of systemic risk in the economics and finance literature, chosen to span key themes and issues in systemic risk measurement and management. We motivate these measures from the supervisory, research, and data perspectives in the main text, and present concise definitions of each risk measure—including required inputs, expected outputs, and data requirements—in an extensive appendix. To encourage experimentation and innovation among as broad an audience as possible, we have developed open-source Matlab code for most of the analytics surveyed, which can be accessed through the Office of Financial Research (OFR).
In July 2010, the U.S. Congress enacted the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd Frank Act), the most comprehensive financial reform bill since the 1930s. Among other things, the Dodd Frank Act created the Financial Stability Oversight Council (FSOC) and Office of Financial Research (OFR). The FSOC has three broad mandates: (1) to identify risks to financial stability arising from events or activities of large financial firms or elsewhere; (2) to promote market discipline by eliminating participants’ expectations of possible government bailouts; and (3) to respond to emerging threats to the stability of the financial system.¹ The starting point for all of these directives is the accurate and timely measurement of systemic risk. The truism that “one cannot manage what one does not measure” is especially compelling for financial stability since policymakers, regulators, academics, and practitioners have yet to reach a consensus on how to define “systemic risk”. While regulators sometimes apply Justice Potter Stewart’s definition of pornography, i.e., systemic risk may be hard to define but they know it when they see it, such a vague and subjective approach is not particularly useful for measurement and
analysis, a pre-requisite for addressing threats to financial stability.
One definition of systemic risk is “any set of circumstances that threatens the stability of or public confidence in the financial system” (Billio, Getmansky, Lo, and Pelizzon, 2010). The European Central Bank (ECB) (2010) defines it as a risk of financial instability “so widespread that it impairs the functioning of a financial system to the point where economic growth and welfare suffer materially”. Others have focused on more specific mechanisms, including imbalances (Caballero, 2009), correlated exposures (Acharya, Pedersen, Philippon, and Richardson, 2010), spillovers to the real economy (Group of Ten, 2001)