Liquidity at risk: joint stress testing of solvency and liquidity
The traditional approach to the stress testing of financial institutions focuses on capital adequacy and solvency. Liquidity stress tests have been applied in parallel to and independently from solvency stress tests, based on scenarios which may not be consistent with those used in solvency stress t...
| Main Authors: | , , |
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| Format: | Internet publication |
| Language: | English |
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International Monetary Fund
2019
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| _version_ | 1826300619097374720 |
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| author | Cont, R Kotlicki, A Valderrama, L |
| author_facet | Cont, R Kotlicki, A Valderrama, L |
| author_sort | Cont, R |
| collection | OXFORD |
| description | The traditional approach to the stress testing of financial institutions focuses on capital adequacy and solvency. Liquidity stress tests have been applied in parallel to and independently from solvency stress tests, based on scenarios which may not be consistent with those used in solvency stress tests. We propose a structural framework for the joint stress testing of solvency and liquidity: our approach exploits the mechanisms underlying the solvency-liquidity nexus to derive relations between solvency shocks and liquidity shocks. These relations are then used to model liquidity and solvency risk in a coherent framework, involving external shocks to solvency and endogenous liquidity shocks arising from these solvency shocks.
We define the concept of 'Liquidity at Risk', which quantifies the liquidity resources required for a financial institution facing a stress scenario. Finally, we show that the interaction of liquidity and solvency may lead to the amplification of equity losses due to funding costs which arise from liquidity needs. |
| first_indexed | 2024-03-07T05:19:55Z |
| format | Internet publication |
| id | oxford-uuid:de895144-784c-4420-8196-f2ba469fcd3f |
| institution | University of Oxford |
| language | English |
| last_indexed | 2024-03-07T05:19:55Z |
| publishDate | 2019 |
| publisher | International Monetary Fund |
| record_format | dspace |
| spelling | oxford-uuid:de895144-784c-4420-8196-f2ba469fcd3f2022-03-27T09:32:58ZLiquidity at risk: joint stress testing of solvency and liquidityInternet publicationhttp://purl.org/coar/resource_type/c_7ad9uuid:de895144-784c-4420-8196-f2ba469fcd3fEnglishSymplectic ElementsInternational Monetary Fund2019Cont, RKotlicki, AValderrama, LThe traditional approach to the stress testing of financial institutions focuses on capital adequacy and solvency. Liquidity stress tests have been applied in parallel to and independently from solvency stress tests, based on scenarios which may not be consistent with those used in solvency stress tests. We propose a structural framework for the joint stress testing of solvency and liquidity: our approach exploits the mechanisms underlying the solvency-liquidity nexus to derive relations between solvency shocks and liquidity shocks. These relations are then used to model liquidity and solvency risk in a coherent framework, involving external shocks to solvency and endogenous liquidity shocks arising from these solvency shocks. We define the concept of 'Liquidity at Risk', which quantifies the liquidity resources required for a financial institution facing a stress scenario. Finally, we show that the interaction of liquidity and solvency may lead to the amplification of equity losses due to funding costs which arise from liquidity needs. |
| spellingShingle | Cont, R Kotlicki, A Valderrama, L Liquidity at risk: joint stress testing of solvency and liquidity |
| title | Liquidity at risk: joint stress testing of solvency and liquidity |
| title_full | Liquidity at risk: joint stress testing of solvency and liquidity |
| title_fullStr | Liquidity at risk: joint stress testing of solvency and liquidity |
| title_full_unstemmed | Liquidity at risk: joint stress testing of solvency and liquidity |
| title_short | Liquidity at risk: joint stress testing of solvency and liquidity |
| title_sort | liquidity at risk joint stress testing of solvency and liquidity |
| work_keys_str_mv | AT contr liquidityatriskjointstresstestingofsolvencyandliquidity AT kotlickia liquidityatriskjointstresstestingofsolvencyandliquidity AT valderramal liquidityatriskjointstresstestingofsolvencyandliquidity |