Working Paper

Systemic risk analysis using forward-looking distance-to-default series

Abstract: Based on contingent claims theory, this paper develops a method to monitor systemic risk in the European banking system. Aggregated Distance-to-Default series are generated using option prices information from systemically important banks and the DJ STOXX Banks Index. These indicators provide methodological advantages in monitoring vulnerabilities in the banking system over time: 1) they capture interdependences and joint risk of distress in systemically important banks; 2) their forward-looking feature endow them with early signaling properties compared to traditional approaches in the literature and other market-based indicators; and 3) they produce simultaneously both smooth and informative long-term signals and quick and clear reaction to market distress.

Keywords: Systemic risk; Banks and banking - Europe;

https://doi.org/10.26509/frbc-wp-201005

Bibliographic Information

Provider: Federal Reserve Bank of Cleveland

Part of Series: Working Papers (Old Series)

Publication Date: 2010

Number: 1005