One of the main contributions of literature on financial networks is the property of financial system called robust-yet-fragile. The financial connections of the system can serve at the same time as shock-absorbers an shock-amplifiers to the financial sector. This makes the system robust, when the magnitude of shock is relatively small, but fragile, when the shock is large.

The literature provides a several theoretical models where a financial system exhibit a regime change depending on the magintude of the shock. when the system is subject to the smaller shock, the damages are dissipated through the financial network. On the other hand, when the shock is above some threshold, the properties of the system changes markedly. The damages are no longer dissipated, but amplified through the network. This makes the effect of connectedness on the system regime-dependent.

This research aims at providing empirical evidence for the regime-dependent effect of connectedness on financial stability. This is achieved by employing the Markov switching volatility model with exogenously provided network connectedness measure of the banking system.