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Federal Reserve Bank of Cleveland
Working Papers (Old Series)
Systemic risk analysis using forward-looking distance-to-default series
Martin Saldías Zambrana
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.


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Martin Saldías Zambrana, Systemic risk analysis using forward-looking distance-to-default series, Federal Reserve Bank of Cleveland, Working Papers (Old Series) 1005, 2010.
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Keywords: Systemic risk ; Banks and banking - Europe
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