Market-Implied Systemic Risk and Shadow Capital Adequacy

53 Pages Posted: 17 Sep 2019

See all articles by Somnath Chatterjee

Somnath Chatterjee

Government of India - Reserve Bank of India; Bank of England

Andreas (Andy) Jobst

International Monetary Fund (IMF) - European Department

Date Written: September 13, 2019


This paper presents a forward-looking approach to measure systemic solvency risk using contingent claims analysis (CCA) as a theoretical foundation for determining an institution’s default risk based on the uncertainty in its asset value relative to promised debt payments over time. Default risk can be quantified as market-implied expected losses calculated from integrating equity market and balance sheet information in a structural default risk model. The expected losses of multiple banks and their non-parametric dependence structure define a multivariate distribution that generates portfolio-based estimates of the joint default risk using the aggregation technique of the Systemic CCA framework (Jobst and Gray, 2013). This market-implied valuation approach (‘shadow capital adequacy’) endogenises bank solvency as a probabilistic concept based on the perceived default risk (in contrast to accounting-based prudential measures of capital adequacy). The presented model adds to the literature of analytical tools estimating market-implied systemic risk by augmenting the CCA approach with a jump diffusion process of asset changes to inform a more comprehensive and flexible assessment of common vulnerabilities to tail risks of the four largest UK commercial banks.

Keywords: systemic risk, contingent claims analysis, jump diffusion, CoVaR, systemic expected shortfall, conditional tail expectation, capital adequacy

JEL Classification: C61, C63, G01, G21, G28

Suggested Citation

Chatterjee, Somnath and Jobst, Andreas A., Market-Implied Systemic Risk and Shadow Capital Adequacy (September 13, 2019). Bank of England Working Paper No. 823, September 2019, Available at SSRN: or

Somnath Chatterjee (Contact Author)

Government of India - Reserve Bank of India ( email )

Bakery Junction Service Road
Thiruvananthapuram, Kerala 695033

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Andreas A. Jobst

International Monetary Fund (IMF) - European Department ( email )

700 19th Street NW
Washington, DC 20431
United States
+1-202-538-2898 (Phone)

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