{
  "title": "Sovereign Risk in Macroprudential Solvency Stress Testing",
  "publication": "IMF Working Papers, December 6, 2019",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2019/12/06/sovereign-risk-in-macroprudential-solvency-stress-testing-48768",
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  "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).",
  "sections": [
    {
      "heading": "Overview and purpose",
      "content": "- Explains the treatment of sovereign risk in macroprudential solvency stress testing, based on experiences in the Financial Sector Assessment Program (FSAP).\n- Emphasizes assessing the system-wide impact of sovereign distress on bank solvency under tail-risk scenarios."
    },
    {
      "heading": "Key methodological components",
      "content": "- Four essential steps in assessing system-wide sovereign risk:\n  - Scope\n  - Loss estimation\n  - Shock calibration\n  - Capital impact calculation\n- Market-consistent valuation approach is central to assessing financial sector resilience in adverse sovereign scenarios.\n- Presents a flexible, closed-form approach to calibrating valuation haircuts based on changes in expected sovereign defaults affecting bank solvency during adverse macroeconomic conditions.\n- Demonstrates the effectiveness of using extreme value theory (EVT) for calibrating shocks and tail-risk assessment, with empirical examples from past FSAPs."
    },
    {
      "heading": "Findings and contributions",
      "content": "- Market-consistent valuation enables consistent measurement of losses from sovereign exposures in stressed scenarios.\n- Closed-form haircut calibration ties changes in expected sovereign defaults directly to solvency impacts on banks.\n- EVT provides an effective framework for modeling extreme sovereign distress events relevant to macroprudential stress testing.\n- Empirical FSAP examples illustrate practical application of the proposed approaches."
    },
    {
      "heading": "Policy implications and recommended practice",
      "content": "- Adopt market-consistent valuation in solvency stress tests involving sovereign risk to capture tail-risk dynamics.\n- Use closed-form haircut calibrations that reflect changes in expected sovereign default probabilities when estimating losses on sovereign exposures.\n- Incorporate EVT-based shock calibration for tail-risk scenarios to improve robustness of macroprudential solvency assessments.\n- Ensure stress-testing frameworks explicitly cover scope, loss estimation, shock calibration, and capital impact calculation for sovereign exposures."
    },
    {
      "heading": "Subjects and keywords (as listed)",
      "content": "- Subjects: 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\n- 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\n\n---\n\n Content in this bundle\n\n- Working Paper\n  - Working Paper (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Working Paper (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2019/12/06/sovereign-risk-in-macroprudential-solvency-stress-testing-48768"
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    "Authors: Andreas Jobst, Hiroko Oura",
    "Published: December 6, 2019",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781513519968.001",
    "Explains the treatment of sovereign risk in macroprudential solvency stress testing, based on experiences in the Financial Sector Assessment Program (FSAP).",
    "Emphasizes assessing the system-wide impact of sovereign distress on bank solvency under tail-risk scenarios.",
    "Four essential steps in assessing system-wide sovereign risk:",
    "Market-consistent valuation approach is central to assessing financial sector resilience in adverse sovereign scenarios.",
    "Presents a flexible, closed-form approach to calibrating valuation haircuts based on changes in expected sovereign defaults affecting bank solvency during adverse macroeconomic conditions.",
    "Demonstrates the effectiveness of using extreme value theory (EVT) for calibrating shocks and tail-risk assessment, with empirical examples from past FSAPs.",
    "Market-consistent valuation enables consistent measurement of losses from sovereign exposures in stressed scenarios.",
    "Closed-form haircut calibration ties changes in expected sovereign defaults directly to solvency impacts on banks.",
    "EVT provides an effective framework for modeling extreme sovereign distress events relevant to macroprudential stress testing.",
    "Empirical FSAP examples illustrate practical application of the proposed approaches.",
    "Adopt market-consistent valuation in solvency stress tests involving sovereign risk to capture tail-risk dynamics.",
    "Use closed-form haircut calibrations that reflect changes in expected sovereign default probabilities when estimating losses on sovereign exposures.",
    "Incorporate EVT-based shock calibration for tail-risk scenarios to improve robustness of macroprudential solvency assessments.",
    "Ensure stress-testing frameworks explicitly cover scope, loss estimation, shock calibration, and capital impact calculation for sovereign exposures.",
    "Subjects: 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",
    "**Working Paper**"
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