Tackling the Volatility Paradox: Spillover Persistence and Systemic Risk

Abstract Financial losses can have persistent effects on the financial system. This article proposes an empirical measure for the duration of these effects, Spillover Persistence. I document that Spillover Persistence is strongly correlated with financial conditions; during banking crises, Spillover Persistence is higher, whereas in the run-up phase of stock market bubbles, it is lower. Lower Spillover Persistence also associates with a more fragile system, for example, a higher probability of future crises, consistent with the volatility paradox. The results emphasize the dynamics of loss spillovers as an important dimension of systemic risk and financial constraints as a key determinant of persistence.