Systemic risk indicator based on implied and realized volatility

Paper: arXiv 2307.05719

Authors: Paweł Sakowski, Rafał Sieradzki, Robert Ślepaczuk

Abstract

We propose a new measure of systemic risk to analyze the impact of the major financial market turmoils in the stock markets from 2000 to 2023 in the USA, Europe, Brazil, and Japan. Our Implied Volatility Realized Volatility Systemic Risk Indicator (IVRVSRI) shows that the reaction of stock markets varies across different geographical locations and the persistence of the shocks depends on the historical volatility and long-term average volatility level in a given market. The methodology applied is based on the logic that the simpler is always better than the more complex if it leads to the same results. Such an approach significantly limits model risk and substantially decreases computational burden. Robustness checks show that IVRVSRI is a precise and valid measure of the current systemic risk in the stock markets. Moreover, it can be used for other types of assets and high-frequency data. The forecasting ability of various SRIs (including CATFIN, CISS, IVRVSRI, SRISK, and Cleveland FED) with regard to weekly returns of S&P 500 index is evaluated based on the simple linear, quasi-quantile, and quantile regressions. We show that IVRVSRI has the strongest predicting power among them.

Complexity vs Empirical Score

• Math Complexity: 3.5/10
• Empirical Rigor: 6.0/10 (capped from 7.5: no out-of-sample test; see penalty flags)
• Quadrant: Street Traders — practical and empirical, lighter on theory

Why this score: The paper introduces a simple yet effective systemic risk indicator (IVRVSRI) that prioritizes low computational burden and minimal model risk over complex mathematics. It excels empirically by validating across multiple global equity markets (2000-2023) and outperforming established benchmarks like SRISK and CATFIN in predictive quantile regressions.

Research Flowchart

  flowchart TD
    A[Research Goal: Develop a simple, low-model-risk Systemic Risk Indicator] --> B[Input Data: Implied Volatility & Realized Volatility 2000–2023<br>USA, Europe, Brazil, Japan]
    B --> C[Construct IVRVSRI<br>IV-RV Systemic Risk Indicator]
    C --> D[Analyze Market Impacts & Shock Persistence]
    C --> E[Evaluate Forecasting Power against CATFIN, CISS, SRISK, Fed<br>via Linear & Quantile Regressions on S&P 500]
    D --> F[Key Outcomes:<br>1. Reaction varies by region; persistence depends on historical/long-term volatility<br>2. IVRVSRI has the strongest predictive power for S&P 500 returns]
    E --> F