The Price of Being a Systemically Important Financial Institution (SIFI)

Dacorogna, Michel M and Busse, Marc (2016): The Price of Being a Systemically Important Financial Institution (SIFI).

Abstract

After reviewing the notion of Systemically Important Financial Institution (SIFI), we propose a first principles way to compute the price of the implicit put option that the State gives to such an institution. Our method is based on important results from Extreme Value Theory (EVT), one for the aggregation of heavy tailed distributions and the other one for the tail behavior of the Value-at-Risk (VaR) versus the Tail-Value-at-Risk (TVaR).

We show how to value in practice is proportional to the VaR of the institution and thus would provide the wrong incentive to the banks even if not explicitly granted. We conclude with a proposal to make the institution pay the price of this option to a fund, whose task would be to guarantee the orderly bankruptcy of such an institution. This fund would function like an insurance selling a cover to clients.

• Item Type: MPRA Paper
• Language: English
• Keywords: Systemic Risk; "Too Big to Fail"; Risk Measure; Value-at-Risk and Tail Value-at- Risk; Option Price; Risk Neutral Distribution; Heavy tail; Pareto; Insurance
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C10 - General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E61 - Policy Objectives ; Policy Designs and Consistency ; Policy Coordination

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