Asymmetric Network Connectedness of Fears

TL;DR

This paper develops forward-looking measures of asymmetric network connectedness of fears in the financial system, using options data to predict macroeconomic conditions and systemic risk.

Contribution

It introduces a novel approach to quantify asymmetric fears in financial networks using options prices, enhancing systemic risk monitoring.

Findings

Asymmetric network connectedness predicts macroeconomic conditions.

Options-based measures provide early warning signals of systemic risk.

Network structure reflects market participants' beliefs about uncertainty.

Abstract

This paper introduces forward-looking measures of the network connectedness of fears in the financial system, arising due to the good and bad beliefs of market participants about uncertainty that spreads unequally across a network of banks. We argue that this asymmetric network structure extracted from call and put traded option prices of the main U.S. banks contains valuable information for predicting macroeconomic conditions and economic uncertainty, and it can serve as a tool for forward-looking systemic risk monitoring.