An Entropy-Based Early Warning Indicator for Systemic Risk

35 Pages Posted: 11 May 2015

See all articles by Monica Billio

Monica Billio

Ca Foscari University of Venice - Dipartimento di Economia

Roberto Casarin

University Ca' Foscari of Venice - Department of Economics

Michele Costola

Ca' Foscari University of Venice

Andrea Pasqualini

Independent

Date Written: May 7, 2015

Abstract

The purpose of this paper is the construction of an early warning indicator for systemic risk using entropy measures. The analysis is based on the cross-sectional distribution of marginal systemic risk measures such as Marginal Expected Shortfall, Delta CoVaR and network connectedness. These measures are conceived at a single institution for the financial industry in the Euro area. We estimate entropy on these measures by considering different definitions (Shannon, Tsallis and Renyi). Finally, we test if these entropy indicators show forecasting abilities in predicting banking crises. In this regard, we use the variable presented in Babeckỳ et al. (2012) and Alessi and Detken (2011) from European Central Bank.

Entropy indicators show promising forecast abilities to predict financial and banking crisis. The proposed early warning signals reveal to be effective in forecasting financial distress conditions.

Keywords: Entropy, systemic risk measures, early warning indicators, aggregation

JEL Classification: C10, C11, G12, G29

Suggested Citation

Billio, Monica and Casarin, Roberto and Costola, Michele and Pasqualini, Andrea, An Entropy-Based Early Warning Indicator for Systemic Risk (May 7, 2015). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 09/WP/2015, Available at SSRN: https://ssrn.com/abstract=2604754 or http://dx.doi.org/10.2139/ssrn.2604754

Monica Billio (Contact Author)

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

HOME PAGE: http://www.unive.it/persone/billio

Roberto Casarin

University Ca' Foscari of Venice - Department of Economics ( email )

San Giobbe 873/b
Venice, 30121
Italy
+39 030.298.91.49 (Phone)
+39 030.298.88.37 (Fax)

HOME PAGE: http://sites.google.com/view/robertocasarin

Michele Costola

Ca' Foscari University of Venice ( email )

Cannaregio 873
Venice, 30121
Italy

Andrea Pasqualini

Independent

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