Integrating Solvency and Liquidity Stress Tests: The Use of Markov Regime-Switching Models
IMF Working Papers, November 15, 2019
Source details
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- Integrating Solvency and Liquidity Stress Tests: The Use of Markov Regime-Switching Models
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Bibliographic details
- Authors: Fei Han, Mindaugas Leika
- Published: November 15, 2019
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513519791.001
Core summary
- Presents a framework to integrate liquidity and solvency stress tests.
- Empirical study based on European bond trading data finds that asset sales haircuts depend on the total amount of assets sold and general liquidity conditions in the market.
- To account for variations in market liquidity, the study uses Markov regime-switching models and links haircuts with market volatility and the amount of securities sold by banks.
- Framework is accompanied by a Matlab program and an Excel-based tool to replicate calculations for any type of traded security and to be used for liquidity and solvency stress testing.
Empirical findings
- Asset sales haircuts depend on:
- the total amount of assets sold.
- general liquidity conditions in the market.
- Haircuts are linked with:
- market volatility.
- the amount of securities sold by banks.
- Data scope and empirical base:
- European bond trading data.
Methodology
- Uses Markov regime-switching models to capture variations in market liquidity, including transitions between regimes such as low-liquidity regime and other liquidity states.
- Links regime states with observable variables (market volatility, volumes sold) to determine haircuts and fire-sale dynamics.
Practical tools and replication
- Includes a Matlab program.
- Includes an Excel-based tool.
- Tools allow replication of calculations for any traded security and application in liquidity and solvency stress testing.
Subjects and keywords (as listed)
- Subjects: Asset and liability management; Asset liquidity; Asset management; Banking; Financial institutions; Financial regulation and supervision; Liquidity; Liquidity risk; Sovereign bonds.
- Keywords: asset class; asset fire sales; asset fire-sale model; Asset liquidity; Asset management; cash flow; fire-sale model; funding shortage; Global; Liquidity; liquidity constraint; liquidity gap; liquidity risk; liquidity shortage; liquidity spiral; low-liquidity regime; market liquidity; market liquidity condition; market liquidity shock; Markov regime-switching models; optimization strategy; shock transmission mechanisms; solvency risk; Sovereign bonds; stress testing; WP.
Content in this bundle
- Working Paper