Sovereign Risk in Macroprudential Solvency Stress Testing

Andreas Jobst () and Hiroko Oura

No 2019/266, IMF Working Papers from International Monetary Fund

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.

Keywords: WP; valuation haircut; zero-coupon bond; macroprudential; sovereign risk; stress testing; HtM securities; discounted cash flow pricing; CDS spread; CDS contract; Credit risk; Bond yields; Yield curve; Credit default swap; Global; Africa (search for similar items in EconPapers)
Pages: 59
Date: 2019-12-06
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Citations: View citations in EconPapers (1)

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