Modeling Banking, Sovereign, and Macro Risk in a CCA Global VAR

63 Pages Posted: 23 Nov 2013

See all articles by Dale F. Gray

Dale F. Gray

International Monetary Fund (IMF); MF Risk

Date Written: October 2013

Abstract

The purpose of this paper is to develop a model framework for the analysis of interactions between banking sector risk, sovereign risk, corporate sector risk, real economic activity, and credit growth for 15 European countries and the United States. It is an integrated macroeconomic systemic risk model framework that draws on the advantages of forward-looking contingent claims analysis (CCA) risk indicators for the banking systems in each country, forward-looking CCA risk indicators for sovereigns, and a GVAR model to combine the banking, the sovereign, and the macro sphere. The CCA indicators capture the nonlinearity of changes in bank assets, equity capital, credit spreads, and default probabilities. They capture the expected losses, spreads and default probability for sovereigns. Key to the framework is that sovereign credit spreads, banking system credit risk, corporate sector credit risk, economic growth, and credit variables are combined in a fully endogenous setting. Upon estimation and calibration of the global model, we simulate various negative and positive shock scenarios, particularly to bank and sovereign risk. The goal is to use this framework to analyze the impact and spillover of shocks and to help identify policies that would mitigate banking system, sovereign credit risk and recession risk - policies including bank capital increases, purchase of sovereign debt, and guarantees.

Keywords: Banking sector, Credit expansion, Sovereign debt, Credit risk, Cross country analysis, Economic models, contingent claims analysis (CCA), global vector autoregression (GVAR)., banking systems, sovereign risk, bank assets, bank capital, bank credit, financial risk, present value, deposit insurance, probability of default, bank liquidity, bank debt, bank bailouts, bank creditors, bank risk, interest expense, bank market, yield to maturity, recapitalization, banking risk, banking sectors, bank spreads

JEL Classification: C51, G01, G13, G21, H63

Suggested Citation

Gray, Dale F., Modeling Banking, Sovereign, and Macro Risk in a CCA Global VAR (October 2013). IMF Working Paper No. 13/218. Available at SSRN: https://ssrn.com/abstract=2358489

Dale F. Gray (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

MF Risk

5921 Searl Terrace
Bethesda, MD 20816

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