How Much SRISK is Too Much?
Abstract: When financial firms are undercapitalized, they are vulnerable to external shocks. This is commonly measured by stress tests or market based measures such as SRISK (systemic risk). More importantly, the natural response to this risk is to raise capital and this can endogenously start a financial crisis. Excessive credit growth can be interpreted as undercapitalization of the financial sector. Hence we can ask how much SRISK can an economy stand and what is the probability of a crisis. Using a crisis intensity variable constructed by the Romers, a Tobit model is estimated for 23 developed economies. The probability of crisis and an SRISK capacity measure can be computed from these estimates. These are plotted for several countries.
Finance Seminars at Caltech are funded through the generous support of The Ronald and Maxine Linde Institute of Economic and Management Sciences (lindeinstitute.caltech.edu) and Stephen A. Ross.