Sovereign Risk in Macroprudential Solvency Stress Testing

December 6, 2019

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Format: Chicago

Andreas Jobst, and Hiroko Oura. Sovereign Risk in Macroprudential Solvency Stress Testing, (USA: International Monetary Fund, 2019) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

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.

Subject: Banking, Bond yields, Credit default swap, Credit risk, Financial institutions, Financial regulation and supervision, Financial sector policy and analysis, Financial services, Money, Stress testing, Yield curve

Keywords: Africa, Bond yields, CDS contract, CDS spread, Credit default swap, Credit risk, Discounted cash flow pricing, Global, HtM securities, Macroprudential, Sovereign risk, Stress testing, Valuation haircut, WP, Yield curve, Zero-coupon bond

Publication Details

Pages:

59
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/266
Stock No:

WPIEA2019266
ISBN:

9781513519968
ISSN:

1018-5941

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