Working Paper: NBER ID: w17490
Authors: Francis X. Diebold; Kamil Yilmaz
Abstract: We propose several connectedness measures built from pieces of variance decompositions, and we argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. We also show that variance decompositions define weighted, directed networks, so that our connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, we track both average and daily time-varying connectedness of major U.S. financial institutions' stock return volatilities in recent years, including during the financial crisis of 2007-2008.
Keywords: connectedness; variance decomposition; financial firms; systemic risk
JEL Codes: C32; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Shocks from one firm (e.g., Citigroup) (F65) | Forecast error variance of another firm (e.g., Bank of America) (G17) |
| Shocks to one financial institution's return volatility (G17) | Influence on other financial institutions (G21) |
| Total connectedness measures (D85) | Variability based on time period analyzed (C22) |
| Connectedness increases dramatically (D85) | During periods of financial distress (e.g., 2007-2008 financial crisis) (G01) |