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An integrated macro‐financial risk‐based approach to the stressed capital requirement

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  • Xiaochun Liu

Abstract

In order to fulfill the stressed minimum capital requirement recently implemented by the Basel III Accord, this paper proposes a risk‐based approach to integrate the change of macro‐financial environments in which financial institutions operate into the modeling of the new required capital charge. Particularly, using a variety of regime‐switching models, I characterize the stressed minimum capital requirement from high risk regimes which are associated with economic recessions and crises. The empirical results show that the proposed approach leads to capital charges 2–3 times higher than those estimated under Basel II Accord, so as to discourage excessive risk taking and hence stabilizing banks' balance sheets. Among competing models, the regime‐switching GJR − GARCH model spends the highest proportion of the out‐of‐sample time in the green zone, which results in the lowest penalties. The results are robust to subsamples.

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  • Xiaochun Liu, 2017. "An integrated macro‐financial risk‐based approach to the stressed capital requirement," Review of Financial Economics, John Wiley & Sons, vol. 34(1), pages 86-98, September.
  • Handle: RePEc:wly:revfec:v:34:y:2017:i:1:p:86-98
    DOI: 10.1016/j.rfe.2017.06.002
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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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