Measuring and Analysing Marginal Systemic Risk Contribution using CoVaR: A Copula Approach

Abstract: This paper is devoted to the quantification and analysis of marginal risk contribution of a given single financial institution i to the risk of a financial system s. Our work expands on the CoVaR concept proposed by Adrian and Brunnermeier as a tool for the measurement of marginal systemic risk contribution. We first give a mathematical definition of CoVaR_{\alpha}^{s|L^i=l}. Our definition improves the CoVaR concept by expressing CoVaR_{\alpha}^{s|L^i=l} as a function of a state l and of a given probability level \alpha relative to i and s respectively. Based on Copula theory we connect CoVaR_{\alpha}^{s|L^i=l} to the partial derivatives of Copula through their probabilistic interpretation and definitions (Conditional Probability). Using this we provide a closed formula for the calculation of CoVaR_{\alpha}^{s|L^i=l} for a large class of (marginal) distributions and dependence structures (linear and non-linear). Our formula allows a better analysis of systemic risk using CoVaR in the sense that it allows to define CoVaR_{\alpha}^{s|L^i=l} depending on the marginal distributions of the losses of i and s respectively and the copula between L^i and L^s. We discuss the implications of this in the context of the quantification and analysis of systemic risk contributions. %some mathematical This makes possible the For example we will analyse the marginal effects of L^i, L^s and C of the risk contribution of i.