Contingent Liabilities and Sovereign Risk: Evidence from Banking Sectors

31 Pages Posted: 6 Sep 2012 Last revised: 18 Nov 2020

See all articles by Serkan Arslanalp

Serkan Arslanalp

International Monetary Fund (IMF)

Yin Liao

Australian National University - The Centre for Applied Macroeconomic Analysis (CAMA); Macquarie University - Department of Applied Finance and Actuarial Studies

Multiple version iconThere are 2 versions of this paper

Date Written: Oct 31, 2012

Abstract

The recent financial crisis has underscored the importance of contingent liabilities for sovereign risk management. However, quantifying contingent liabilities remains a difficult task and, partly as a result, they continue to be recognized as a liability only when the contingency materializes. This paper proposes a simple analytical model to estimate contingent liabilities that arise from (implicit and explicit) government guarantees to the banking sector. In doing so, we model the banking sector as a portfolio of banks and the government as a portfolio manager that may need to cover expected and unexpected losses of such a portfolio. This standardized method allows us to construct cross-country estimates on potential costs of bank failures so that contingent liabilities from the banking sector can be better tracked and monitored. Furthermore, we use these estimates and the corresponding sovereign CDS spreads from 32 countries, to empirically test whether the contingent liabilities from the banking sector is a significant exploratory variable for the determination of sovereign risk. Our results suggest that a one percent of GDP increase in contingent liabilities is associated with an increase in sovereign CDS spreads of 24 basis points in advanced countries and 75 basis points in emerging economies.

Keywords: Contingent Liabilities, Sovereign Risk, Systemic Risk, Banking Sector, Expected Loss, Unexpected Loss

JEL Classification: G13, G21, G38

Suggested Citation

Arslanalp, Serkan and Liao, Yin and Liao, Yin, Contingent Liabilities and Sovereign Risk: Evidence from Banking Sectors (Oct 31, 2012). 25th Australasian Finance and Banking Conference 2012, Available at SSRN: https://ssrn.com/abstract=2142437 or http://dx.doi.org/10.2139/ssrn.2142437

Serkan Arslanalp

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Yin Liao (Contact Author)

Australian National University - The Centre for Applied Macroeconomic Analysis (CAMA) ( email )

Canberra, Australian Capital Territory 2601
Australia

Macquarie University - Department of Applied Finance and Actuarial Studies ( email )

Eastern Rd.
North Ryde
Sydney, NSW 2109
United States

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