Integrating Solvency and Liquidity Stress Tests: The Use of Markov Regime-Switching Models

November 15, 2019

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Format: Chicago

Fei Han, and Mindaugas Leika. Integrating Solvency and Liquidity Stress Tests: The Use of Markov Regime-Switching Models, (USA: International Monetary Fund, 2019) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

The paper presents a framework to integrate liquidity and solvency stress tests. An empirical study based on European bond trading data finds that asset sales haircuts depend on the total amount of assets sold and general liquidity conditions in the market. To account for variations in market liquidity, the study uses Markov regime-switching models and links haircuts with market volatility and the amount of securities sold by banks. The framework is accompanied by a Matlab program and an Excel-based tool, which allow the calculations to be replicated for any type of traded security and to be used for liquidity and solvency stress testing.

Subject: Asset and liability management, Asset liquidity, Asset management, Banking, Financial institutions, Financial regulation and supervision, Liquidity, Liquidity risk, Sovereign bonds

Keywords: Asset class, Asset fire sales, Asset fire-sale model, Asset liquidity, Asset management, Cash flow, Fire-sale model, Funding shortage, Global, Liquidity, Liquidity constraint, Liquidity gap, Liquidity risk, Liquidity shortage, Liquidity spiral, Low-liquidity regime, Market liquidity, Market liquidity condition, Market liquidity shock, Markov regime-switching models, Optimization strategy, Shock transmission mechanisms, Solvency risk, Sovereign bonds, Stress testing, WP

Publication Details

Pages:

41
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/250
Stock No:

WPIEA2019250
ISBN:

9781513519791
ISSN:

1018-5941

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