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Sovereign Risk in Macroprudential Solvency Stress Testing

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  • Andreas Jobst
  • Ms. Hiroko Oura

Abstract

This paper explains the treatment of sovereign risk in macroprudential solvency stress testing, based on the experiences in the Financial Sector Assessment Program (FSAP). We discuss four essential steps in assessing the system-wide impact of sovereign risk: scope, loss estimation, shock calibration, and capital impact calculation. Most importantly, a market-consistent valuation approach lies at the heart of assessing the resilience of the financial sector in a tail risk scenario with sovereign distress. We present a flexible, closed-form approach to calibrating haircuts based on changes in expected sovereign defaults affecting bank solvency during adverse macroeconomic conditions. This paper demonstrates the effectiveness of using extreme value theory (EVT) in this context, with empirical examples from past FSAPs.

Suggested Citation

  • Andreas Jobst & Ms. Hiroko Oura, 2019. "Sovereign Risk in Macroprudential Solvency Stress Testing," IMF Working Papers 2019/266, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2019/266
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    References listed on IDEAS

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    1. Edward Altman & Andrea Resti & Andrea Sironi, 2004. "Default Recovery Rates in Credit Risk Modelling: A Review of the Literature and Empirical Evidence," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 33(2), pages 183-208, July.
    2. Viral V. Acharya, 2018. "Understanding and managing interest rate risk at banks," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 11(2), pages 218-231, May.
    3. Anil Ari, 2015. "Sovereign Risk and Bank Risk-Taking," Working Papers 202, Oesterreichische Nationalbank (Austrian Central Bank).
    4. Chatterjee, Somnath & Jobst, Andreas, 2019. "Market-implied systemic risk and shadow capital adequacy," Bank of England working papers 823, Bank of England.
    5. Miguel A. Segoviano, 2006. "Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing Under Data-Restricted Environments," IMF Working Papers 2006/283, International Monetary Fund.
    6. Eric Wong & Cho-Hoi Hui, 2009. "A Liquidity Risk Stress-Testing Framework with Interaction between Market and Credit Risks," Working Papers 0906, Hong Kong Monetary Authority.
    7. Andreas Jobst & Ms. Li L Ong & Mr. Christian Schmieder, 2013. "A Framework for Macroprudential Bank Solvency Stress Testing: Application to S-25 and Other G-20 Country FSAPs," IMF Working Papers 2013/068, International Monetary Fund.
    8. Andreas Jobst & Ms. Li L Ong & Mr. Christian Schmieder, 2017. "Macroprudential Liquidity Stress Testing in FSAPs for Systemically Important Financial Systems," IMF Working Papers 2017/102, International Monetary Fund.
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    Cited by:

    1. Aneta Hryckiewicz & Petra Pawlowski & Piotr Michal Mazur & Marcin Borsukb, 2022. "Sovereign Debt Holding and Bank Sensitivity toward Market Risk: An Alternative View of the Bank–Sovereign Problem," International Journal of Central Banking, International Journal of Central Banking, vol. 18(5), pages 1-52, December.

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