A new paper from the Basel Committee is aimed at assessing systemic risk of major financial institutions
BASEL - The Basel Committee on Banking Supervision has published a new paper proposing a framework for measuring and stress testing the systemic risk posed by a group of major financial institutions.
The paper measures systemic risk by the price of insurance against financial distress, based on before-the-event measures of default probabilities of individual banks and forecasted asset return correlations.
It says it is important to use realised correlations estimated from high-frequency equity return data to improve the accuracy of forecasted correlations.
Basel Committee stress-testing methodology, using an integrated micro-macro model, looks at the dynamic linkages between the health of major US banks and macro-financial conditions.
The theoretical insurance premium suggested by the framework that would be charged to protect against losses that equal or exceed 15% of total liabilities of 12 major US financial firms was $110 billion in March 2008, up to a possible high of $250 billion in July 2008.
The paper can be read here.
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