Systemic risk: how to improve it with credit risk

In this work, after a description of what systemic risk and credit risk represent in the financial world and of how they are regulated by international institutions, we take into consideration two of the newest methods to calculate systemic risk: the first is the Conditional Joint Probability of Default, proposed by Bulgarian economist Deyan Radev; the second is CoRisk, proposed by Italian economist Paolo Giudici and Laura Parisi. The first is based on the correlation between different countries and focuses on the cascade effects caused by the default of a sovereign in a interconnected financial world. The second is based on vector autoregressive regression, correlation networks and CDS spreads, and the probability of default that depends on the previous values of the same measure for country i and on the default probabilities of the correlated countries. Both represent a new way to face the problem, because they consider the possibility of default of a sovereign, and what it can represent for all the other countries that are connected to it. This is different from the previously proposed models, because the interest was principally on the possible default of a sistemically important financial institution, like Lehmann Brothers in 2008. We take into consideration ten different countries, dividable into two groups: the five world’s biggest borrower/lenders (core countries) and the five who had the biggest problems with the financial crisis of 2007-09, the so-called PIIGS (peripheral countries). We observe the trend of CDS spreads of the ten countries from July 2007 to December 2016, and then we use theresults obtained with the two proposed measures in order to make a comparison between the models.