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An Early Warning on Systemic Risk

By Robert Engle, Michael Armellino Professor of Finance, Director, Center For Financial Econometrics & Affiliated Faculty, Statistics Group

engle systemic risk article

Because it uses available market data, the ultimate goal of our work is to provide regulators with a new tool to evaluate systemic risk that is more efficient, replicable, and transparent than individual scrutiny of confidential company financial and accounting data.

The world’s global financial system can now be better monitored, thanks to NYU Stern’s Volatility Lab. Under the direction of Finance Professor and Nobel Laureate Robert Engle, the Lab has launched the NYU Stern Systemic Risk Rankings, a weekly rating and ordering by level of risk incurred by the largest U.S. financial institutions.

The rankings use stock quotations and other market data, from 1990 to the present, that can provide an early warning to help regulators identify threats to the overall health of the financial system. The rankings consider company size, exposure to loss of market capitalization, and leverage.

Several indices are presented and combined to predict a firm’s expected losses in a future financial crisis. Engle’s award-winning work on the ARCH model underpins the calculations. The Marginal Expected Shortfall (MES), developed by Stern Finance Professors Viral Acharya, Thomas Phillipon, and Matthew Richardson, orders firms by the expected loss on equity each would experience if the market falls by at least 2 percent.

Ultimately, the Systemic Risk Rankings rank firms by the percentage of total system risk each is expected to contribute in a future crisis.

Said Engle: "Because it uses available market data, the ultimate goal of our work is to provide regulators with a new tool to evaluate systemic risk that is more efficient, replicable, and transparent than individual scrutiny of confidential company financial and accounting data."

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