A Structural Model of Sovereign Credit and Bank Risk
- October 25 , 3:00 - 4:30, Hill Center 552
In the recent past, sovereign credit took center stage in the market's perception of risk. This occurred not only because certain countries emerged as potential debtors in default, but also because some major economies showed signs of fundamental strain in their public finances. The financial market effects of potential sovereign default and ensuing bank weakness and contagion, and the undermined capability of governments to sustain the Keynesian support for their vulnerable economies demonstrate the paramount importance of accurate and rigorous risk measurement of sovereign entities and financial institutions.
In this presentation we make an overview of a model designed for this task. It builds on established credit risk methodology for corporate entities known from the seminal work of Merton, and takes a new direction to adapt the default option argument to a sovereign debt setting. The proposed model caters to economic intuition and resorts to explicit measures of macro economic activity as its buildings blocks. We differentiate sovereign entities into three distinct categories, and adapt our general arguments to each of these groups. Furthermore, we pursue the connection between the viability of sovereign entities and the viability of the jurisdictional financial institution. Finally, we juxtapose the model results with metrics of credit risk from the financial markets, as a reality check of the success of approach.
Emilian Belev, CFA, Northfield Information Services
Emilian heads the development of Northfield's Enterprise Risk analytics for the last 13 years. His domain of responsibilities include modeling equity and fixed income, currency, equity, interest rate, and credit derivatives, structured products, directly owned real estate, private equity, and infrastructure, and developing an integrated framework for these asset classes to be analyzed side-by-side in a coherent, accurate, and economically logical fashion. He has introduced various innovative methodologies in the areas of convertible bonds modeling, MBS path dependency, efficiency of numerical derivative pricing algorithms, credit risk among tranches of seniority, infrastructure investments, and directly owned real estate. Emilian has presented on some of these topics at various industry events in North America and Europe. Prior to joining Northfield, Emilian has been with State Street Global Advisors. Emilian is an actively involved CFA charter holder, holder of the Certificate in Advanced Risk and Portfolio Management, a member and founding member of respectively QWAFAFEW Boston and QWAFAFEW Toronto, a member of the PRMIA expert advisory group for Market Risk, and a winner of the 2013 PRMIA award for New Frontiers in Risk Management.