The Two Faces of Interbank Correlation

Abstract

We decompose the correlation of bank stock returns into a systemic risk compon- it is important to distinguish between the two sources of interbank correlations when quantifying systemic risk at banks. Our decomposition also permits us to estimate the marginal gains from diversi…cation, which turn out to be rapidly declining with bank size. Since large banks are additionally found to display high levels of the systemic risk component, they are hence predominantly exposed to the undesirable source of interbank correlation.