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A Primer for Risk Measurement of Bonded Debt From the Perspective of a Sovereign Debt Manager

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  • Michael G. Papaioannou
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    Abstract

    This paper presents some conventional and new measures of market, credit, and liquidity risks for government bonds. These measures are analyzed from the perspective of a sovereign''s debt manager. In particular, it examines duration, convexity, M-square, skewness, kurtosis, and VaR statistics as measures of interest rate exposure; a VaR statistic as the prominent measure of exchange rate exposure; the balance sheet approach (or contingent claims approach), and its consequent probability of default as the most promising measure of credit risk exposure; and an elasticity approach and a VaR statistic to measure liquidity risk. Along with the formulas for the various statistics proposed, we provide simple examples of their application to some common risk valuation cases. Finally, we present an integrated approach for the simultaneous estimation of a portfolio''s interest rate and exchange rate risk using the VaR methodology. The integrated approach is then extended to also include N risk factors. This approach allows us to measure the total risk of a portfolio, provided that the volatilities and correlations among the risk factors can be estimated.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/195.

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    Length: 49
    Date of creation: 01 Aug 2006
    Date of revision:
    Handle: RePEc:imf:imfwpa:06/195

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    Related research

    Keywords: Credit risk; Debt management; bond; bonds; probability; standard deviation; covariance; kurtosis; normal distribution; skewness; correlation; derivative; equation; cash flows; bond portfolio; probability distribution; coupon bond; correlations; bond debt; interest rate risk; debt stock; standard deviations; monte carlo simulation; present value; bond prices; statistics; zero coupon bond; government bond; portfolio of bonds; bond markets; random numbers; government bonds; convexity bond; probabilities; nonlinearity; bond portfolios; cash flow; bond price; statistic; random number; coupon bonds; poisson process; bond holders; net cash flows; callable bonds; bond default; government bond markets; functional form; normal probability distribution; bond trading; discount rate; denominated bond; financial institutions; equations; partial derivative; normal distributions; random variable; zero coupon bonds; bond portfolio management; debt stocks; credit derivatives; integral; bond holder; international financial markets; prediction; interest rate fluctuations; bond portfolio manager; bond duration; individual bonds; premium bond; covariances; rate bonds; option valuation; discount bond; survey; stochastic processes; diagonal matrix; income bonds; treasury bond; principal components analysis; zero-coupon bonds; stock portfolio; computations; random variables; price derivative; statistical measures; premium bonds; international bond; stock of debt; discount bonds; derivatives transactions; international finance; money market; hedging; monte carlo methods; corporate bonds; fixed income bonds; bond returns; callable bond; random error; money markets; bond portfolio managers; forecasting; par bond;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 39-69.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    3. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," NBER Working Papers 9908, National Bureau of Economic Research, Inc.
      • Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany.
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
    5. Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
    6. Linsmeier, Thomas J. & Pearson, Neil D., 1996. "Risk measurement: an introduction to value at risk," ACE Reports 14796, University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics.
    7. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
    8. repec:rus:hseeco:123922 is not listed on IDEAS
    9. Michael T. Gapen & Dale F. Gray & Cheng Hoon Lim & Yingbin Xiao, 2005. "Measuring and Analyzing Sovereign Risk with Contingent Claims," IMF Working Papers 05/155, International Monetary Fund.
    10. Anil Bangia & Francis X. Diebold & Til Schuermann & John D. Stroughair, 1998. "Modeling Liquidity Risk With Implications for Traditional Market Risk Measurement and Management," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-062, New York University, Leonard N. Stern School of Business-.
    11. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
    12. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
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    Cited by:
    1. Magdalena Polan & Parmeshwar Ramlogan & Carlos I. Medeiros, 2007. "A Primeron Sovereign Debt Buybacks and Swaps," IMF Working Papers 07/58, International Monetary Fund.
    2. Udaibir S. Das & Yinqiu Lu & Michael G Papaioannou & Iva Petrova, 2012. "Sovereign Risk and Asset and Liability Management," IMF Working Papers 12/241, International Monetary Fund.

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