State Street launches Systemic Risk Index, an index that measures the US equity market’s vulnerability to market shocks

State Street Global Markets, the investment research and trading arm of State Street Corporation, today announced the launch of its Systemic Risk Index, an index that measures the US equity market’s vulnerability to market shocks.

The Systemic Risk Index describes the degree to which a small number of macro risk factors, as opposed to stock- or industry-specific news, can drive stock returns.

The components of State Street’s Systemic Risk Index, covering the US equity market, are made up of approximately 60 industrial sectors. The Index provides a single, daily measure of fragility and can help portfolio managers to determine when they should consider hedging their portfolios or change investment strategies. The Systemic Risk Index can be used in conjunction with State Street’s Turbulence Indices, because it can provide an early signal of the onset of ‘unusualness’ in the marketplace. “Unusualness” is defined as the covariance-adjusted distance between that day’s observation, which is comprised of a set of contemporaneous returns, and the multivariate mean in multi-dimensional space. Turbulence is defined using this multivariate distance to quantify unusual patterns of investment returns.

The Systemic Risk Index captures the extent to which markets are unified or tightly coupled. A tightly coupled market is driven by a relatively small number of macro risk factors and can be highly sensitive to negative news, such as economic announcements or new regulations. When markets are tightly coupled, they are more fragile because negative shocks spread more quickly and broadly. Conversely, when markets are loosely linked and less fragile, these negative shocks may be isolated to specific industries or sectors.

“In today’s market, investors are continually looking for new ways to manage risk in their portfolios,” said Will Kinlaw, managing director and head of Portfolio and Risk Management Research at State Street Global Markets. “State Street’s Systemic Risk Index is designed to provide institutional investors with an early indication of fragility within the US market so that they can adjust their strategies accordingly and maximize returns even in a difficult market environment.”

The Systemic Risk Index was developed by State Street Associates in collaboration with Windham Capital Management, LLC, a Boston-based investment management boutique. “Shifts in this index have coincided with many global financial crises, making it a very valuable tool for varying equity exposure in the US market,” said Mark Kritzman, a senior partner at State Street Associates and president and CEO of Windham Capital Management.