Persistence in Financial Connectedness and Systemic Risk

TL;DR

This paper introduces frequency domain measures to analyze dynamic financial linkages with varying persistence, helping identify systemic risk sources and offering insights into market stability.

Contribution

It develops novel frequency domain techniques to distinguish between transitory and persistent financial linkages and tests their statistical significance.

Findings

Substantial differences in linkages among US financial volatilities.

Persistent linkages relate to heterogeneously persistent systemic risk sources.

Tools for market participants to assess systemic risk dynamics.

Abstract

This paper characterises dynamic linkages arising from shocks with heterogeneous degrees of persistence. Using frequency domain techniques, we introduce measures that identify smoothly varying links of a transitory and persistent nature. Our approach allows us to test for statistical differences in such dynamic links. We document substantial differences in transitory and persistent linkages among US financial industry volatilities, argue that they track heterogeneously persistent sources of systemic risk, and thus may serve as a useful tool for market participants.