THE METHODOLOGY FOR MEASURING FINANCIAL CONTAGION: THE CASE STUDY OF BANK DEFAULT RISK SIMULATION

Abstract

The paper focuses on the methods used for measuring financial contagion through simulation of the bank default risk viewed as a trigger event. Systemic risk and financial contagion as well as the mechanism which enables system risk implementation are considered taking into account such aspects of financial contagion as the existence of overlapping channels of risk transfer, interbank and independent bank levels, and feedback loops impact. The methodology for analyzing financial contagion outcomes is based on the approach allowing for the latent factor. The author examines the methodology while applied for simulating bank default risk. Basic approaches to measure financial contagion in time and structural perspectives have been suggested. An important aspect of the financial effect of contagion is the fact that it occurs in the dynamics which implies a more significant impact than might initially be expected. A weak banking system may have a negative impact on the state as the subsidization of one bank may increase the risk to the whole banking system, which; in turn; will reduce the effectiveness of subsidies for chosen bank, etc. The lasting effect generates a reverse effect loop of financial contagion. The final part of the article shows the similar channels which eventually may provoke financial contagion in Russia.

Keywords

• cds model
• financial contagion
• regression analysis
• correlation analysis