The Impact of Lehman Brothers’ Bankruptcy on the Banking System During the Subprime crisis

In this article, we applied the DCC-GARCH model developed by Cappiello, Engle, and Sheppard (2006) to analyze the predictability of correlations among bank stock returns, particularly during the subprime crisis. This approach enabled us to examine the dynamics of conditional correlations between various financial institutions and evaluate the impact of Lehman Brothers’ bankruptcy on the U.S. banking system. Our primary goal was to determine whether the DCC- GARCH model could effectively capture these dynamics and to identify the banks most affected by Lehman Brothers’ collapse.The results revealed that the conditional correlations between Lehman Brothers and other banks were dynamic, with all sampled banks being significantly impacted by the event on September 15, 2008. A notable and temporary increase in correlations was observed, supporting the contagion hypothesis. Even banks that had not shown high correlations with Lehman Brothers prior to its bankruptcy were affected, with the effect being more pronounced for banks located in the same state, while geographically distant banks exhibited relative resilience to the contagion.