Multi yield curve stress-testing framework incorporating temporal and cross tenor structural dependencies

Emmanouil Karimalis, Ioannis Kosmidis (i.kosmidis@ucl.ac.uk) and Gareth Peters (gareth.peters@ucl.ac.uk)
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Ioannis Kosmidis: Department of Statistical Science, University College London (UCL)., Postal: Department of Statistical Science, University College London (UCL)
Gareth Peters: Department of Statistical Science, University College London (UCL)., Postal: Department of Statistical Science, University College London (UCL).

No 655, Bank of England working papers from Bank of England

Abstract: We develop a new multi-curve modelling framework for the term-structure of interest rates that can generate consistent cross-country stressed scenarios allowing for significant spillover effects between economies. Modern models of the term structure of interest rates typically fail to capture jointly time and cross-curve dependencies and are not used for stress-testing purposes. Our methodology is able to jointly model the temporal and cross-country dependence structure of interest rate curves and associate movements in the interest rates and cross-country spreads with movements in macroeconomic variables as well as market-wide and country-specific measures of liquidity and credit quality. We apply our methodology to generate contemporaneous stressed scenarios to a set of European yield curves. Motivated by the recent eurozone debt crisis, we apply shocks to Italian and Spanish liquidity and credit variables and evaluate the impact of these shocks on several bond portfolio strategies. The empirical findings suggest that both country-specific liquidity and credit measures are important in explaining the dynamic behaviour of European sovereign interest rate curves and their dependence structure. Nevertheless, their importance varies across time, shock types and investment horizons.

Keywords: Stress-testing; term structure; yield curve; liquidity risk; credit risk (search for similar items in EconPapers)
JEL-codes: G11 G18 G20 G21 G32 G38 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2017-04-10
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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