Systemic Risk of the Non-Financial Sector and Its Application in Portfolio Risk Management: Marginal Expected Shortfall Approach

Document Type : Research Paper

Authors

1 Ph.D. Candidate., Department of Accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran.

2 Prof., Department of Accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran.

3 Assistant Prof., Department of Management, Faculty of Administrative Sciences and Economics University of Isfahan, Isfahan, Iran.

10.22059/frj.2025.377227.1007607

Abstract

Objective
Systemic risk, with contagion between different parts of the market, causes financial crises and instability in the economy; therefore, it is necessary to recognize, measure, control, and combat systemic risk. Since financial institutions have extensive connections with all institutions and can transfer and spread risk, in the financial literature, the systemic risk of the financial sector has a special place, and most of the research conducted on the systemic risk field has been devoted to the financial industry, while the non-financial sector in this field has received less attention. On the other hand, non-financial corporations (NFCs) are also connected to each other and to the financial sector, and as a result, NFCs have potentially systemic importance. Therefore, considering the importance of systemic risk in the economy's stability and the position of the non-financial sector in the society's economy, the systemic importance of non-financial institutions and industries should be evaluated and explained. Also, knowing the drivers of systemic risk in NFCs helps to identify important systemic NFCs, make economic decisions, and formulate appropriate rules. On the other hand, in portfolio risk management decisions, the individual risk criteria of institutions are often used, and risk transmission between institutions has not been adequately considered. Therefore, for better portfolio risk management, systemic risk should also be included in decisions. According to the mentioned cases, the current research aims to comprehensively examine the systemic risk of the non-financial sector from four different perspectives. For this purpose, the systemic importance of non-financial corporations was investigated, and the corporations were ranked in terms of systemic risk. Also, the systemic importance of various industries in Iran's capital market was investigated, and the ranking of all industries in terms of systemic risk was determined. In addition, firm-level characteristics related to the systemic risk of non-financial corporations were identified. And at the end, the application of systemic risk in portfolio risk management by asset managers, retail investors, and policymakers was explained.
 
Methods
To measure systemic risk, the Marginal Expected Shortfall criterion (MES) was used and analyses were performed at the firm, industry, and random portfolio levels. For this purpose, 284 financial and non-financial corporations, in addition to the financial industry and non-financial industries, and three separate portfolio groups, with each portfolio group consisting of 100 random portfolios, were examined from 2008 to 2022. The systemic importance of non-financial corporations and industries was determined by comparing the median of MES between non-financial corporations and financial corporations, as well as non-financial industries and the financial industry. Also, by ranking, the most important and least important corporations and industries were determined from a systemic perspective. Additionally, a new estimation method known as 'random effects within-between' (REWB) regression was employed to understand firm-level characteristics associated with MES in non-financial corporations. In REWB regressions, the cross-sectional (between) and longitudinal (within) relationships between each firm characteristic and systemic risk are estimated simultaneously. Finally, to evaluate the effect of the systemic importance of corporations and the weight assigned to systemically important corporations on portfolio risk, the median of downside risk measures was compared between different portfolio groups.
 
Results
The findings of the research confirmed the systemic importance of non-financial corporations and non-financial industries. Also, separate analysis results on large corporations in the capital market indicate that the systemic importance of large non-financial corporations is almost equal to the systemic importance of large financial corporations. In addition, during the research period, Isfahan Mobarakeh Steel Company and Damavand Mining Company were found to have the highest and lowest ranks of systemic importance, respectively, among companies. The rubber and plastic industry and the pharmaceutical industry were also identified as having the highest and lowest ranks of systemic importance, respectively. In addition, firm-level characteristics of Beta, Value at Risk, Accounts Receivable, Size, Cash Holding, Dividend, Asset Tangibility, and External Financial Dependence are directly and significantly related to MES. Furthermore, the systemic importance of corporations and the weight assigned to systemically important corporations significantly affect the downside risk criteria of the investment portfolio.
 
Conclusion
To maintain economic stability, the systemic risk of the non-financial sector should be considered, as well as that of the financial sector. For example, knowing the drivers of systemic risk in non-financial companies can help to control systemic risk. Also, retail investors, portfolio managers, and regulators of mutual funds, by including the systemic risk of all companies in their decisions, can achieve better portfolio risk management.

Keywords

Main Subjects

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Financial Research Journal
Volume 27, Issue 4
2025
Pages 877-904

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