This paper sheds light on the impact of market risk measures on systemic risk. Market risk, which is captured by the volatility of stock market returns, is also decomposed into systematic and idiosyncratic risks.
The author uses the five-factor asset pricing model and systemic risk methodologies to derive market and systemic risk measures, respectively. Using a sample of 2,667 US banks for over 30 years and employing panel data estimation techniques, the author tests the said relationship.
It is shown that idiosyncratic risk can surge systemic risk, while systematic risk plays a less important role. Results survive a battery of tests, including different systemic risk measures, controlling causality and interacting with bank size, market fear and crisis periods.
These findings call for regulatory intervention, especially for large banks with high idiosyncratic risk.
This is the first paper that provides a more granular picture of the relationship between market and systemic risk from the US banking industry for more than 30 years.
