DISCUSSION OF THE ARTICLE BY T.ADRIAN AND M.BRUNNERMEIER « COVAR » J.C.ROCHET TOULOUSE SCHOOL OF ECONOMICS

CONTEXT OF THE PAPER Regulators need to renew their toolkit Academic economists have to contribute by proposing new ideas This paper is a good example: it is likely to have an impact on regulators However it is not blunt enough: my discussion tries to be

WHAT THE PAPER DOES (1) Starting point: the (so far) most popular risk measure among regulators (i.e. VaR) does not capture systemic risk Main objective: measure the contribution of each bank to systemic risk Main idea: compute the VaR of the « financial system » conditional on the bank’s hitting its own VaR

WHAT THE PAPER DOES (2) Using quantile regressions one could estimate the VaR of the « system », conditional on bank i’s portfolio value This estimation would be constant over time, so the authors prefer to estimate CoVaR from systematic risk factors Instead of using particular banks they constitute « portfolios » representing different criteria: leverage, transformation, book-to-market and size

WHY DOING THIS?(1) Story 1: measure externalities=loss inflicted to the system by bank i when it is in financial distress (fire sales, closure,..) CoVaR= VaR of the system conditional on bank i hitting its own VaR PROBLEMS: Causality not clear Not in your data so far

WHY DOING THIS?(2) Story 2: Macro-prudential Regulation: measure systematic risk (herding) component of bank i’s portfolio CoVaR= VaR of bank i conditional on the system hitting its VaR Much better (close to the beta) but: VaR is a terrible criterion for regulators Conditioning should be on the system above its VaR not just equal

WHAT COULD BE DONE Story 3: SYSTEMIC RISK REGULATION Expected Shortfall (or better risk measure that gives increasing weights to bigger systemic events) conditional on a systemic crisis (the system being above its VaR)

AN ILLUSTRATION(1)

AN ILLUSTRATION (2) Alternative measures of systemic risk:

CONCLUSION The role of academic is not to please regulators VaR has repeatedly revealed that it is a terrible risk measure for regulatory purposes CoVaR is a good direction for assessing systemic risk contributions of each bank But it has some drawbacks: let us try to be more imaginative