The question of the study is: “How do systematic shocks affect financial instability?” It is an interesting topic to investigate because systemic shocks are idiosyncratic shocks that permeate the entire financial sector and lead to financial instability that affects actual activity. This study deals with the identification of systemic shock and thus systemic risk at three levels. The main goal of the first level is to identify and analyze systemic shocks and their spread from the financial sector to the real economy.
I have reviewed two studies conducted on related topics. The first study is carried out by Nasir et al. (2019), and it discusses the role of oil shocks in the macroeconomy. This study will be useful to analyze because it also uses VAR models to assess the importance of shocks in the economy. The next study is conducted by Kaplan and Violante (2018), and it also refers to the shocks in the macroeconomy. The study addresses fluctuations in the economy, aggregate shocks, and analysis of distributional issues. Thus, it will be useful to examine the effect of economic shocks concerning the mentioned spheres.
The study will use a combination of econometric tools to identify different types of shock. Some are known, such as structural VAR models, while others are lesser-known, such as signal extraction and identification of unobservable components. The study will also develop a general equilibrium model to determine not only how temporary shocks in asset valuation become permanent but also how specific shocks become systemic.
The impact of a significant increase in one bank’s credit risk on other banks in the system will be examined in a second-level study focusing on the first transmission channel. Using multiple measurements of individual credit risk and expected shortfall as a starting point, this study analyzes risk transfer in the financial industry in the best possible way for each scenario. Thus, I want to use data from different bank reports. Doing so will allow me to take a deep investigation into the current issues related to the financial risks that organizations face. Moreover, I would like to conduct interviews with financial consulting experts to know their opinion on the research question. I think that this type of data will be relevant to my project because I want to research the current situation in the macroeconomy. Gathering information from the mentioned data sources will make my study more practical.
Finally, the third level determines which systemic shocks and macroeconomic turmoil have the greatest impact on the long-term and cross-cutting behavior of financial asset betas. There are banks whose performance is strongly correlated with macroeconomic conditions. These banks are more likely to be systematic if they are also highly leveraged. Therefore, understanding the macroeconomic causes that link the returns of these banks to macroeconomic activity is an important step in determining the origin of the system institution.
Similarly, I would like to consider the simultaneous determinants of the risk premium on return on assets and the risk premium on volatility. Concurrency allows you to explicitly investigate the cause of the risk premium based on the expected return rather than the usual historical average return. Thanks to the options trading carried out by the bank sample, the expected return can be explicitly included in the analysis.
References
Kaplan, G., & Violante, G. L. (2018). Microeconomic heterogeneity and macroeconomic shocks. Journal of Economic Perspectives, 32(3), 167-94. Web.
Nasir, M. A., Al-Emadi, A. A., Shahbaz, M., & Hammoudeh, S. (2019). Importance of oil shocks and the GCC macroeconomy: A structural VAR analysis. Resources Policy, 61, 166-179. Web.