Multi Yield Curve Stress-Testing Framework Incorporating Temporal and Cross Tenor Structural Dependencies

34 Pages Posted: 10 Apr 2017

See all articles by Emmanouil Karimalis

Emmanouil Karimalis

Bank of England

Ioannis Kosmidis

Department of Statistical Science, University College London

Gareth Peters

Department of Actuarial Mathematics and Statistics, Heriot-Watt University; University College London - Department of Statistical Science; University of Oxford - Oxford-Man Institute of Quantitative Finance; London School of Economics & Political Science (LSE) - Systemic Risk Centre; University of New South Wales (UNSW) - Faculty of Science

Date Written: April 10, 2017

Abstract

We develop a new multi-curve modelling framework for the term-structure of interest rates that can generate consistent cross-country stressed scenarios allowing for significant spillover effects between economies. Modern models of the term structure of interest rates typically fail to capture jointly time and cross-curve dependencies and are not used for stress-testing purposes. Our methodology is able to jointly model the temporal and cross-country dependence structure of interest rate curves and associate movements in the interest rates and cross-country spreads with movements in macroeconomic variables as well as market-wide and country-specific measures of liquidity and credit quality. We apply our methodology to generate contemporaneous stressed scenarios to a set of European yield curves. Motivated by the recent eurozone debt crisis, we apply shocks to Italian and Spanish liquidity and credit variables and evaluate the impact of these shocks on several bond portfolio strategies. The empirical findings suggest that both country-specific liquidity and credit measures are important in explaining the dynamic behaviour of European sovereign interest rate curves and their dependence structure. Nevertheless, their importance varies across time, shock types and investment horizons.

Keywords: Stress-testing, term structure, yield curve, liquidity risk, credit risk

JEL Classification: G11, G18, G20, G21, G32, G38

Suggested Citation

Karimalis, Emmanouil and Kosmidis, Ioannis and Peters, Gareth, Multi Yield Curve Stress-Testing Framework Incorporating Temporal and Cross Tenor Structural Dependencies (April 10, 2017). Bank of England Working Paper No. 655. Available at SSRN: https://ssrn.com/abstract=2949763 or http://dx.doi.org/10.2139/ssrn.2949763

Emmanouil Karimalis (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Ioannis Kosmidis

Department of Statistical Science, University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

Gareth Peters

Department of Actuarial Mathematics and Statistics, Heriot-Watt University ( email )

Edinburgh Campus
Edinburgh, EH14 4AS
United Kingdom

HOME PAGE: http://garethpeters78.wixsite.com/garethwpeters

University College London - Department of Statistical Science ( email )

1-19 Torrington Place
London, WC1 7HB
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

University of Oxford Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

London School of Economics & Political Science (LSE) - Systemic Risk Centre ( email )

Houghton St
London
United Kingdom

University of New South Wales (UNSW) - Faculty of Science ( email )

Australia

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