Factor Model for Stress-testing with a Contingent Claims Model of the Chilean Banking System (EPub)
International Monetary Fund, Apr 1, 2008 - Business & Economics - 57 pages
This paper derives risk indicators for the major Chilean banks based on contingent claims analysis, an extension of Black-Scholes-Merton option-pricing theory. These risk indicators are clearly tied to macroeconomic and financial developments in Chile and outside, but bank responses are highly heterogeneous. To reduce the number of variables linked to the banks' risk to a tractable number, we apply principal component analysis. Vector autoregressions of risk indicators with the most significant factors show strong ties from financial markets and regional developments. Impulse response functions from these factors are derived, which allow for scenario testing. The scenarios derived in the paper illustrate how the magnitude and persistence of responses of bank credit risk can vary across banks in the system.
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Calibrating Bank CCA Balance Sheets and Risk
RiskNeutral Probability of Default for Aggregated
Relating Default Risk to Macroeconomic Variables
Significant Factors Output from
Impulse Response Functions
Areas for Further Research
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assessing asset return asset value assumption bank assets bank risk bank’s banking sector risk banks show Brazilian presidential elections Brazilian real calculated calibrate capital adequacy CCA model Central Bank changes Chile CONTINGENT CLAIMS ANALYSIS credit risk crisis Crouhy cyclical factors cyclical variables default barrier derived distance to distress distance-to-distress distress barrier domestic factor effect estimate expected retum factor loadings Figure financial institutions ﬁnancial-market ﬁnancials factor held by banks impact Impulse response functions impulse responses interest-rate and cyclical lags larger banks loss given default macro variables macroeconomic variables Merton Model MKMV months Moody’s paper percent period price of risk principal component analysis probability of default promised payments put option risk measures risk-adjusted risk-free interest risk-free interest rate risk-free rate risk-neutral default probability risky debt sample scenario testing Sharpe Ratio significant smaller banks stepwise regressions strongly U.S. interest rates U.S. yield curve value of assets yield curve