How to Calculate Systemic Risk Surcharges

This chapter analyzes a scheme to charge financial firms for their systemic risk contributions, based on the price of their contingent capital insurance. It provides an explicit calculation formula for contingent capital insurance and illustrates how the systemic risk surcharge varies with institution size, its leverage, risk (equity volatility), and importantly, its correlation with the rest of the economy or with the systemically important part of the financial sector. Calculations of both the tax and the insurance premium for major financial firms prior to the 2007 financial crisis show that the measure accurately chose the systemic firms, consistent with recent statistical-based measures of systemic risk.