Dynamic modeling of systemic risk and firm value: A case of Pakistan

Abstract

The study examines the systemic risk of banking sector in Pakistan and elucidates the factors that exacerbate the systemic risk taking. First, a systemic risk measure ∆CoVaR is applied to analyze the contribution of individual institution to the whole financial system. Secondly, systemic risk and firm value are modeled in static and dynamic frameworks to measure the factors that build systemic risk and firm value. Most importantly, the study highlights the sector level variables munificence, dynamism and concentration are also important in comprehending the risk dynamics along with the much-emphasized firm and country level variables, notably size, political stability, and bank claims. The results imply that the repercussions of excessive risk taking can be ameliorated by increasing liquidity requirements and having a close watch on leverage. Accordingly, monetary policy should be aligned with macro prudential policy to alleviate systemic risk. Furthermore, the Granger causality results indicate that systemic risk engenders idiosyncratic risk and not vice versa, implying regulation of systemic risk can lower the idiosyncratic risk as well. Last but not the least, systemic risk has positive effect on valuation, implying systemic risk cannot be curbed by sheer market discipline and requires external intervention.

Keywords

• systemic risk
• ∆covar
• sectoral variables
• bank valuation
• micro and macro prudential regulations