Systemic Risk Early Warning System: A Micro-Macro Prudential Synthesis

J.P. Fouque and J.A. Langsam (Eds.), Handbook on Systemic Risk, Cambridge University Press (2013)

Posted: 4 Apr 2013

See all articles by Mikhail V. Oet

Mikhail V. Oet

Case Western Reserve University - Weatherhead School of Management; Federal Reserve Banks - Federal Reserve Bank of Cleveland

Ryan Eiben

Indiana University

Timothy Bianco

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Dieter Gramlich

Baden-Wuerttemberg Cooperative State University Mosbach (DHBW)

Stephen J. Ong

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Jing Wang

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: September 28, 2012

Abstract

From the financial supervisor’s point of view, an early warning system involves an ex ante approach to regulation, targeted to predict and prevent crises. An efficient EWS allows timely ex ante policy action and can reduce the need for ex post regulation. This chapter builds on existing microprudential and macroprudential early warning systems (EWSs) to propose a hybrid class of models for systemic risk, incorporating the structural characteristics of the financial system and a feedback amplification mechanism. The models explain financial stress using data from the five largest bank holding companies, regressing institutional imbalances using an optimal lag method. The z-scores of institutional data are justified as explanatory imbalances. The models utilize both public and proprietary supervisory data. The Systemic Assessment of Financial Environment (SAFE) EWS monitors microprudential information from systemically important institutions to anticipate the buildup of macroeconomic stresses in the financial markets at large. To the supervisor, SAFE offers a toolkit of possible institutional actions that can be used to diffuse the buildup of systemic stress in the financial markets. A hazard inherent in all ex ante models is that the model’s uncertainty may lead to wrong policy choices. To mitigate this risk, SAFE develops two modeling perspectives: a set of medium-term (six-quarter) forecasting specifications that gives policymakers enough time to take ex ante policy action, and a set of short-term (two-quarter) forecasting specifications for verification and adjustment of supervisory actions. Individual financial institutions may utilize the public version of SAFE EWS to enhance systemic risk stress testing and scenario analysis. This chapter shows the econometric results and robustness support for the SAFE set of models. The discussion of results addresses the usability and usefulness tests of supervisory data. In addition, the chapter investigates and suggests which action thresholds are appropriate for this EWS.

Keywords: Systemic risk, early warning system, financial stress index, microprudential, macroprudential, structural characteristics, feedback, liquidity amplification, contagion

JEL Classification: G01, G21, G28, C25, C53

Suggested Citation

Oet, Mikhail V. and Eiben, Ryan and Bianco, Timothy and Gramlich, Dieter and Ong, Stephen J. and Wang, Jing, Systemic Risk Early Warning System: A Micro-Macro Prudential Synthesis (September 28, 2012). J.P. Fouque and J.A. Langsam (Eds.), Handbook on Systemic Risk, Cambridge University Press (2013), Available at SSRN: https://ssrn.com/abstract=2244597

Mikhail V. Oet (Contact Author)

Case Western Reserve University - Weatherhead School of Management ( email )

364 PBL Building
Cleveland, OH 44106
United States

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States
216.774.2684 (Phone)
216.579.2932 (Fax)

Ryan Eiben

Indiana University ( email )

107 S Indiana Ave
100 South Woodlawn
Bloomington, IN 47405
United States

Timothy Bianco

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Dieter Gramlich

Baden-Wuerttemberg Cooperative State University Mosbach (DHBW) ( email )

Lohrtalweg 10
Mosbach, 74821
Germany

Stephen J. Ong

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Jing Wang

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

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