How to Calculate Systemic Risk Surcharges

There is a growing view that systemic risk arises due to loss of intermediation for the overall economy – a negative externality – when the financial sector becomes under-capitalized as a whole. In turn, the systemic risk contribution of an individual financial firm can be defined as its share of this negative externality. Motivated by this intuition, a number of authors have proposed a “Pigovian tax” that would charge each firm in relation to its marginal potential impact on the aggregate risk of the financial sector. This paper discusses and analyzes several measurement strategies that could be used to estimate such systemic risk surcharges. Some empirical evidence is provided which shows how these measurements line up with the loss of capitalization of financial firms during the financial crisis of 2007-2009. 1 The authors are all at New York University Stern School of Business, 44 West 4 St., New York, NY, 10012, and members of the NBER. We are grateful for useful comments from Rob Engle, Jim Poterba, participants at the Research Conference on Quantifying Systemic Risk organized by the NBER and the Federal Reserve Bank of Cleveland, our discussants Mathias Drehmann and Dale Gray, the reviewers and the organizers Joseph Haubrich and Andrew Lo.