Systemic Risk in European Banking - Evidence from Bivariate GARCH Models

This paper attempts to assess the Europe-wide systemic risk in banking. We employ a bivariate GARCH model to estimate conditional correlations between European bank stock indices. These correlations are used as an indication for the interdependencies amongst the banking business in Europe and hence for the systemic risk potential. We employ several tests to assess the development of systemic risk: a non-parametric test of constancy of the correlation, a test of parallel shifts in the correlation at pre-specified events, and a test for a linear time trend in the correlations. The results show that many of the conditional correlations exhibit an upward move in the last years. This is an indication that the economic factors determining the European banking business have become more similar and that the systemic risk potential has increased.

Schüler, Martin and Michael Schröder (2003), Systemic Risk in European Banking - Evidence from Bivariate GARCH Models, ZEW Discussion Paper No. 03-11, Mannheim.