Working Paper No. 325
By Marco Stringa and Allan Monks
Understanding interlinkages in a financial system is an integral part of the assessment of its stability. This paper employs an event study technique to assess the significance of interlinkages from the UK life insurance sector to the UK banking system in times of stress. The paper uses a thorough methodology to enhance standard event study techniques by adjusting for autocorrelation and heteroskedasticity when calculating the abnormal returns' forecast errors and for the offsetting effects in cumulative abnormal returns. We take an original approach by introducing the use of trading volumes to detect significant reactions not captured by the use of equity prices. The paper shows evidence of interlinkages from the UK life insurance to the UK banking sector, and concludes that contagion is driven by banks' ownership of life insurance assets and only occurs during events that have hit the life insurance sector as a whole.