Estimating Systemic Risk in the International Financial System

This paper develops methods for assessing the risk of a systemic failure in the global banking system. We examine a sample of 334 banks (representing 80 % of global bank equity) in 28 countries around global financial crises such as the Asian and Russian crises and September 11, 2001. We show that cumulative negative abnormal returns for the subset of banks not di-rectly exposed to a negative shock (unexposed banks) rarely exceed a few percent. More pre-cise point estimates of the likelihood of systemic failure are obtained from structural models. These estimates suggest that systemic risk is limited even during major financial crises. For example, maximum likelihood estimation of bank failure probabilities implied by equity prices suggests the Asian crisis induced less than a 1 % increase in the probability of systemic failure. We also obtain estimates of systemic risk implied by equity option prices of U.S. and European banks. The largest values are obtained for the Russian crisis and September 11 which show increases in estimated average default probabilities of around 1-2%. Taken to-gether our results suggest statistically significant, but economically small, increases in sys-temic risk around even the worst financial crises of the last 10 years. Although policy re