Measuring Systemic Risk: Common Factor Exposures and Tail Dependence Effects

Wan Chien Chiu, Juan Ignacio Peña, Chih Wei Wang

Research output: Contribution to journalArticlepeer-review

2 Scopus citations


We model systemic risk using a common factor that accounts for market-wide shocks and a tail dependence factor that accounts for linkages among extreme stock returns. Specifically, our theoretical model allows for firm-specific impacts of infrequent and extreme events. Using data on the four sectors of the US financial industry from 1996 to 2011, we uncover two key empirical findings. First, disregarding the effect of the tail dependence factor leads to a downward bias in the measurement of systemic risk, especially during weak economic times. Second, when these measures serve as leading indicators of the St. Louis Fed Financial Stress Index, measures that include a tail dependence factor offer better forecasting ability than measures based on a common factor only.

Original languageEnglish
Pages (from-to)833-866
Number of pages34
JournalEuropean Financial Management
Issue number5
StatePublished - 1 Nov 2015


  • Correlated jumps
  • Predictability
  • Systemic risk
  • Tail dependence effects


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