Systemic Risk and Financial Consolidation: Are They Related?

Overview: The creation of a number of very large and sometimes increasingly complex financial institutions, resulting in part from the on-going consolidation of the financial system, has raised concerns that the degree of systemic risk in the financial system may have increased. The paper argues that firm interdependencies, as measured by correlation of stock returns, provide an indicator of systemic risk potential. It analyzes the dynamics of the stock return correlation of a sample of U.S. large and complex banking organizations (LCBOs) over 1988.1999, and find a significant positive trend in stock return correlation. This finding is consistent with the view that the systemic risk potential in the financial sector appears to have increased over the last decade. In addition, this article also relates firms’ return correlations to their consolidation activity by estimating measures of the consolidation elasticity of correlation. Consolidation at the sample LCBOs appears to have contributed to LCBOs interdependencies. However, consolidation elasticities of correlation exhibit substantial time variation, and likely declined in the latter part of the decade. Thus, factors other than consolidation have also been responsible for the upward trend in return correlations.

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Format: PDF | Size: 3,062KB | Date: Jun 2001 | Pages: 28