Adverse risk interaction: An integrated approach |
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Institution: | 1. Universitat Autònoma de Barcelona, Departament d''Economia Aplicada, Edifici B, 08193 Bellaterra, Barcelona, Spain;2. Academia General Militar, Centro Universitario de la Defensa de Zaragoza, Ctra. de Huesca s/n, 50090 Zaragoza, Spain;1. Department of Economic Theory, Universitat de Barcelona, 08034 Barcelona, Spain;2. Complutense Institute for International Studies, Universidad Complutense de Madrid, 28223 Madrid, Spain |
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Abstract: | This paper studies adverse interaction between credit and market risk. We develop a comprehensive Merton-type model, in which payment ability of borrowers is driven by the overall economic growth, while the level of their liabilities is sensitive to market variables. To illustrate the model, we apply numerical simulations to estimate credit, market and integrated Value at Risk from the loss distribution using industry-wide data from the Serbian banking sector. We show that—even after accounting for presence of market risk in the banking book—the total risk remains higher than the simple sum of credit and market risk. The results emphasize the importance of integrated approach to assessment of economic capital. |
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Keywords: | risk interaction integrated market and credit risk assessment banking book economic capital macroeconomic stress tests |
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