Journal Article

Does Systemic Risk in the Financial Sector Predict Future Economic Downturns?

Linda Allen, Turan G. Bali and Yi Tang

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 25, issue 10, pages 3000-3036
Published in print October 2012 | ISSN: 0893-9454
Published online September 2012 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhs094
Does Systemic Risk in the Financial Sector Predict Future Economic Downturns?

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  • Economics
  • Banking
  • Econometric and Statistical Methods and Methodology: General
  • Single Equation Models; Single Variables

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We derive a measure of aggregate systemic risk, designated CATFIN, that complements bank-specific systemic risk measures by forecasting macroeconomic downturns six months into the future using out-of-sample tests conducted with U.S., European, and Asian bank data. Consistent with bank “specialness,” the CATFIN of both large and small banks forecasts macroeconomic declines, whereas a similarly defined measure for both nonfinancial firms and simulated “fake banks” has no marginal predictive ability. High levels of systemic risk in the banking sector impact the macroeconomy through aggregate lending activity. A conditional asset pricing model shows that CATFIN is priced for financial and nonfinancial firms.

Keywords: G01; G21; G12; C13; C22

Journal Article.  16037 words.  Illustrated.

Subjects: Economics ; Banking ; Econometric and Statistical Methods and Methodology: General ; Single Equation Models; Single Variables

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