The recent economic turmoil beginning in late 2007 has challenged businesses of all sizes. Firms have been faced with a great deal of uncertainty regarding sales and the economic outlook. At the same time, the recent downturn has dramatically impacted the availability and terms of credit. Over the 2007-2009 period, financial institutions have reported tightening their credit standards for approving loans (SLOOS).
Understanding the origins of stock market volatility has long been atopic of considerable interest to both policy makers and market practitioners. Policy makers are interested in the main determinants of volatility and in its spillover effects on real activity. Market practitioners are mainly interested in the direct effects time-varying volatility exerts on the pricing and hedging of plain vanilla options and more exotic derivatives. In both cases, forecasting stock market volatility constitutesa formidable challenge but also a fundamental instrument to manage the risks faced by these institutions.
The global financial crisis of 2007/8 has highlighted the intertwined nature of financial systems. The emergence of financial instruments in the form of credit default swaps, collateralized debt obligations, and other credit derivative products vastly increased the connectivity between financial institutions worldwide. The heavy reliance of many of these institutions on short-term wholesale funding markets resulted, moreover, in a dramatic increase in rollover risk at a system level. What initially began as a localized difficulty in the US sub-prime mortgage market rapidly escalated beyond the United States once some financial institutions were found to be in difficulty, investors became wary of lending to each other and interbank markets quickly froze, pushing many banks and other financial intermediaries into difficulty.
