Quantifying endogenous and exogenous shocks to financial sector systemic risk: A comparison of GFC and COVID-19

Abstract

In this study, we use segregated endogenous and exogenous shocks to large banks’ returns to compare the effect of each on financial sector systemic risk. We use the copula-CoVaR methodology and GARCH (1,1) with time-varying moments to model the marginal distribution function and bivariate probability distribution of the tail returns. We find that endogenous risk dominates exogenous risk in the financial system. A comparison of the 2008 global financial crisis and COVID-19 reveals that the crisis aggravates only as exogenous shocks to the system persist. Additionally, we find that large banks reduce the total risk of the system in normal times but increase the risk of the financial system in crisis times. Our findings have important implications for policymakers, investors, and portfolio managers. © 2024 Board of Trustees of the University of Illinois