Essays on Systemic Risk

Chapter 1: Introduction Chapter 2: Systemic Risk: Is the Banking Sector Special? In this paper we empirically investigate the degree of systemic risk in the banking sector versus other industry sectors in the United States and in Germany. We characterize the systemic risk in each sector by the lower tail dependence of stock returns. Our study differs from the existing literature in three aspects. First, we compare the degree of systemic risk in the banking sector with other sectors in the economy. Second, we analyze how the systemic risk depends on the state of the economy. Third, we address the problem of systemic risk in an international context by comparing the US and the German banking system. Our study shows in most cases considered that the systemic risk of the banking sector is significantly larger than in all other sectors. Especially it differs from the systemic risk in the insurance sector, the second strongly regulated financial subsystem. Moreover, the degree of systemic risk is higher under adverse market conditions. Finally, we find that the banking sector in Germany shows a lower systemic risk than the US banking sector. Chapter 3: Intra-Industry Contagion Effects of Earnings Surprises in the Banking Sector In this paper we investigate whether contagion is present in the banking sector by analyzing how banks are affected by negative earnings surprises from their competitors. The banking sector is of crucial importance for the economy and, thus, highly regulated on an individual bank level. However, a high degree of contagion risk should call for a regulation of the financial network rather than solely regulating on an individual level. To be able to make a judgment about the magnitude of possible contagion effects we compare the results of the banking sector with the results of the non-banking industries. We find that earnings surprises cause significant contagion in the banking sector. In contrast, we do not find this effect in the non-banking sectors, including the insurance sector. The magnitude of contagion in the banking sector is positively related with the size of the bank reporting an earnings surprise, as well as the size of the affected banks. Chapter 4: Portfolio Management in the Presence of Systemic Risk In this paper we empirically investigate the consequences of systemic risk for stock market investors. To tackle this issue, we consider two different investment strategies. One strategy being crisis conscious, i.e. taking the possibility of systemic events into account - the other one being crisis ignorant and thus, disregarding systemic risk. We compare the optimal portfolio choices and investment results of these strategies in an historical simulation, using almost three decades of historical stock price data. Our main findings are as follows: the crisis conscious investor tends to choose less extreme portfolio weights for individual stocks than the ignorant investor. The overall risky investment is, however, of similar size for both. By ignoring the possibility of systemic events, the crisis ignorant strategy performs significantly worse from the viewpoint of expected return as well as expected utility. Chapter 5: Concluding Remark