Abstract

This paper investigates the contagion risk for Australian-owned authorized deposit taking institutions (ADIs) spilling from the US and UK banks. We hypothesized that Australian ADIs are prone to extreme shocks experienced by its US and UK counterparts. We define four discrete events for the Australian banking sector in terms of the number of banks exceeding at a time an extreme value. The extreme value is defined as the 90th percentile on the negative tail of the distribution of changes in the distance to default obtained through Black and Scholes (1973) and Merton (1974) formula. Then we fit a multinomial logistic model (MLM) to relate these events to the number of exceedances (extreme events) occurring in the US and the UK in the previous day for the time period September 2006 to September 2011. The MLM estimates reveal strong contagion effects for Australian ADIs from the US and UK banks.

Keywords

authorised deposit taking institution (ADI), contagion risk, extreme value theory, distance to default, multinomial logistic model

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