How Useful Are Aggregate Measures of Systemic Risk?

Loosely speaking, "systemic risk" refers to a financial system shock that is large enough to have severe negative consequences for the real economy. Following the financial crisis of 2008-2009, a large literature has emerged that attempts to quantify and measure systemic risk. In this paper we focus on some of the more popular systemic risk indicators from this literature and ask how well they work, in the following sense: What information above what is readily observable in the market do we learn from these systemic risk indicators? Several popular measures provide very little incremental information beyond that contained in traditional market stress proxies, such as implied volatilities and credit spreads. However, when tail risk estimates for individual firms are aggregated after first being passed through a step function, the resultant systemic risk indicator, after controlling for market based measures of stress, still shows economically significant forecasting ability over a one to one and a half year time horizon