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Measuring Systemic Risk

We present a simple model of systemic risk and show how each financial institution’s contribution to systemic risk can be measured and priced. An institution’s contribution, denoted systemic expected shortfall (SES), is its propensity to be undercapitalized when the system as a whole is undercapitalized, which increases in its leverage, volatility, correlation, and tail-dependence. Institutions internalize their externality if they are “taxed” based on their SES. Through several examples, we demonstrate empirically the ability of components of SES to predict emerging systemic risk during the financial crisis of 2007-2009.

JEL codes: G01, G18

Key words: systemic risk, risk pricing, systemic expected shortfall, risk internalization

Suggested citation: Acharya, Viral V., Lasse H. Pedersen, Thomas Philippon, and Matthew Richardson, 2010. “Measuring Systemic Risk,” Federal Reserve Bank of Cleveland, Working Paper no. 10-02.

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