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Systemic Risk In The Financial System: Capital Shortfalls Under Brexit, The U.S. Elections, And The Italian Referendum

Recent episodes of stress in the financial system fostered a great deal of discussion regarding new supervisory and regulatory tools for financial institutions. The recent introduction of additional capital requirements for Systemically Important Financial Institutions (SIFIs) is an example of concrete measures taken by regulators to mitigate systemic risk.

Systemic Risk in the Financial System

In order to assist market participants in assessing and tracking systemic risk in the financial system, the V-Lab of the NYU-Stern School of Business developed a quantitative indicator, called SRISK, which estimates the expected capital shortfall faced by a firm in a potential future financial crisis. Conceptually, SRISK is similar to the stress tests that are regularly applied to financial institutions; however, it is based exclusively on publicly available information (market and accounting data) and is quick and inexpensive to compute. Firms with a high capital shortfall in a crisis – that is when capital is low in the financial system – are the ones with the potential to extend the crisis and impact the broader economy.

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In this new whitepaper, Rob Engle, Nobel Prize winner and Director of the NYU-Stern Volatility Institute,  and Cristiano Zazzara, Managing Director, S&P Global Market Intelligence, use SRISK to quantify the estimated capital shortfalls of financial institutions under three relevant stress events that occurred in 2016: Brexit, the Trump election, and the Italian Referendum. We refer to these events collectively as BRUMPIT.

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