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- Typology for flight-to-quality episodes and downside risk measurementPublication . Gubareva, Mariya; Borges, Maria RosaWe propose a total return-based framework to measure downside risk associated with phenomenon of capital outflows from riskier to safer financial markets. The proposed method consists of three elements: (i) the general definition of the flight-to-quality (FtQ) phenomenon, (ii) the typological classification of the flight-to-quality occurrences for associating them with the phases of the business cycle and (iii) the automated technique to diagnose the time frames and to measure the impact of flight-to-quality on financial instruments. The proposed framework is applied to analyse the global-scale capital inflows/outflows from emerging markets public debt to the US Treasuries and vice versa. The results show that different phases of business cycles and GDP growth rates, including turning points, could be associated with flights-to-quality of different types and causality origins. Addressing downside risk crystallizations in flight-to-quality occurrences, new perspectives of integrated interest rate risk and credit risk management are discussed. For strengthening financial stability, we suggest the use of flight-to-quality windows as scenarios for stress testing, both for banks and financial institutions
- Governed by the Cycle: Direct and Inverted Interest-Rate Sensitivity of Emerging Market Corporate DebtPublication . Gubareva, Mariya; Borges, Maria Rosas proposed. Our focus is centered at price sensitivity of modeled investment grade and high yield portfolios to changes in the present value of modeled portfolios composed of safe-haven assets, which define risk-free interest rates. Our methodology is based on blended yield indexes. Modeled investment horizons are always kept above one year thus allowing to derive empirical implications for practical strategies of interest rate risk management in the banking book. As our study spans over the period 2002 – 2015, it covers interest rate sensitivity of assets under the pre-crisis, crisis, and post-crisis phases of the economic cycles. We demonstrate that the emerging market corporate bonds both, investment grade and high yield types, depending on the phase of a business cycle exhibit diverse regimes of sensitivity to interest rate changes. We observe switching from a direct positive sensitivity under the normal pre-crisis market conditions to an inverted negative sensitivity during distressed turmoil of the recent financial crisis, and than back to direct positive but weaker sensitivity under new normal post-crisis conjuncture. Our unusual blended yield-based approach allows us to present theoretical explanations of such phenomena from economics point of view and helps us to solve an old controversy regarding positive or negative responses of credit spreads to interest rates. We present numerical quantification of sensitivities, which corroborate with our conclusion that hedging of interest rate risk ought to be a dynamic process linked to the phases of business cycles as we evidence a binary-like behavior of interest rate sensitivities along the economic time. Our findings allow banks and financial institutions for approaching downside risk management and optimizing economic capital under Basel III regulatory capital rules.
- Impact of the Covid-19 on liquidity of emerging market bondsPublication . Gubareva, MariyaWe analyze liquidity of the emerging market (EM) bonds during the Covid-19 fueled uncertainty. Using bid/offer spreads we demonstrate that the apogee of both, liquidity and credit stresses is reached in late-March, and that although liquidity has improved since then, it has not yet returned to the pre-Covid levels. In particular, we find that the EM financials are more resilient to liquidity shocks than the EM corporates and sovereigns. Moreover, we observe a decoupling in the dynamics of the liquidity and credit risk metrics, as credit spreads have been tightening very slowly due to the Covid-19-triggered repricing of default risk.
- Interest rate, liquidity, and sovereign risk: derivative-based VaRPublication . Gubareva, Mariya; Borges, Maria RosaPurpose – The purpose of this paper is to study connections between interest rate risk and credit risk and investigate the inter-risk diversification benefit due to the joint consideration of these risks in the banking book containing sovereign debt. Design/methodology/approach – The paper develops the historical derivative-based value at risk (VaR) for assessing the downside risk of a sovereign debt portfolio through the integrated treatment of interest rate and credit risks. The credit default swaps spreads and the fixed-leg rates of interest rate swap are used as proxies for credit risk and interest rate risk, respectively. Findings – The proposed methodology is applied to the decade-long history of emerging markets sovereign debt. The empirical analysis demonstrates that the diversified VaR benefits from imperfect correlation between the risk factors. Sovereign risks of non-core emu states and oil producing countries are discussed through the prism of VaR metrics. Practical implications – The proposed approach offers a clue for improving risk management in regards to banking books containing government bonds. It could be applied to access the riskiness of investment portfolios containing the wider spectrum of assets beyond the sovereign debt. The approach represents a useful tool for investigating interest rate and credit risk interrelation. Originality/value – The proposed enhancement of the traditional historical VaR is twofold: usage of derivative instruments’ quotes and simultaneous consideration of the interest rate and credit risk factors to construct the hypothetical liquidity-free bond yield, which allows to distil liquidity premium.
- Rethinking Framework of Integrated Interest Rate and Credit Risk Management in Emerging Markets.Publication . Gubareva, Mariya; Borges, Maria RosaThis chapter reassesses the economics of interest rate risk management in light of the global financial crisis by developing a derivative-based integrated treatment of interest rate and credit risk interrelation. The decade-long historical data on credit default swap spreads and interest rate swap rates are used as proxy measures for credit risk and interest rate risk, respectively. An elasticity of interest rate risk and credit risk, considered a function of the business cycle phases, maturity of instruments, economic sector, creditworthiness, and other macroeconomic parameters, is investigated for optimizing economic capital. This chapter sheds light on how financial institutions may address hedge strategies against downside risks implementing the proposed derivative-based integrated treatment of interest rate and credit risk assessment allowing for optimization of interest rate swap contracts. The developed framework of integrated interest rate and credit risk management is of special importance for emerging markets heavily dependent on foreign capital as it potentially allows emerging market banks to improve risk management practices in terms of capital adequacy and Basel III rules. Analyzing diversification versus compounding effects, it allows enhancing financial stability through jointly optimizing Pillar 1 and Pillar 2 economic capital
- Interest Rate (In)sensitivity of Emerging Market Corporate Debt: Economic Analysis based on 2002-2015 Empirical EvidencePublication . Gubareva, Mariya; Borges, Maria RosaInterest rate sensitivity assessment framework based on fixed income yield indexes is developed and applied to two types of emerging market corporate debt: investment grade and high yield exposures. Our research advances beyond the correlation analyses focused on comovements in yields and/or spreads of risky and risk-free assets. We show that correlationbased analyses of interest rate sensitivity could appear rather inconclusive and, hence, we investigate the bottom line profit and loss of a hypothetical model portfolio of corporates. We consider historical data covering the period 2002 – 2015, which enable us to assess interest rate sensitivity of assets during the development, the apogee, and the aftermath of the global financial crisis. Based on empirical evidence, both for investment and speculative grades securities, we find that the emerging market corporates exhibit two different regimes of sensitivity to interest rate changes. We observe switching from a positive sensitivity under the normal market conditions to a negative one during distressed phases of business cycles. This research sheds light on how financial institutions may approach interest rate risk management, evidencing that even plain vanilla portfolios of emerging market corporates, which on average could appear rather insensitive to the interest rate risk in fact present a binary behavior of their interest rate sensitivities. Our findings allow banks and financial institutions for optimizing economic capital under Basel III regulatory capital rules.
- Rethinking Economic Capital Management through the Integrated Derivative-based Treatment of Interest Rate and Credit RiskPublication . Gubareva, Mariya; Borges, Maria RosaThis research revisits the economic capital management regarding banking books of financial institutions exposed to the emerging market sovereign debt. We develop a derivative-based integrated approach to quantify economic capital requirements for considered jointly interest rate and credit risk. Our framework represents a major contribution to the empirical aspects of capital management. The proposed innovative modeling allows applying standard historic value-at-risk techniques developed for stand-alone risk factors to evaluate aggregate impacts of several risks. We use the time-series of credit default swap spreads and interest rate swap rates as proxy measures for credit risk and interest rate risk, respectively. An elasticity of interest rate risk and credit risk, considered a function of the business cycle phases, maturity of instruments, creditworthiness, and other macroeconomic parameters, is gauged by means of numerical modeling. Our contribution to the new economic thinking regarding the interest rate risk and credit rate risk management consists in their integrated treatment as the dynamics of interest rate and credit spreads is found to demonstrate the features of automatic stabilizers of each other. This research sheds light on how financial institutions may address hedge strategies against downside risks. It is of special importance for emerging markets heavily dependent on foreign capital as it potentially allows emerging market banks to improve risk management practices in terms of capital adequacy and Basel III rules. From the regulatory perspective, by taking into account inter-risk diversification effects it allows enhancing financial stability through jointly optimizing Pillar 1 and Pillar 2 economic capital.
- Binary interest rate sensitivities of emerging market corporate bondsPublication . Gubareva, Mariya; Borges, Maria RosaWe develop a framework to assess interest rate sensitivities of emerging market corporate debt. Our analysis, based on yield indexes, is applied to investment grade and high yield portfolios. We reach beyond correlation-based analyses of interest rate sensitivity and keep our scope centered at capital gains of emerging market corporates and U.S. government bonds portfolios. Our empirical analysis spans over the period 2002–2015. We address interest rate sensitivity of assets during the ignition, apogee, and the aftermath of the global financial crisis. Based on historical data series, we evidence that the emerging market corporate bonds exhibit two different regimes of sensitivity to interest rate changes. We observe switching from a positive sensitivity under the normal market conditions to a negative one during distressed phases of business cycles and provide economical explanations of such phenomena. We show that emerging market corporate bonds, which on average could appear rather insensitive to the interest rate risk, in fact, present binary interest rate sensitivities. This research sheds light on how financial institutions may approach interest rate risk management including the downside risk hedge. Our findings allow banks and financial institutions to optimize economic capital under Basel III regulatory capital rules.
- Historical Interest Rate Sensitivity of Emerging Market Sovereign Debt: Evidence of Regime Dependent BehaviorPublication . Gubareva, MariyaInterest rate sensitivity of USD-denominated emerging market sovereign debt over 1997-2017 is studied through comparative price dynamics of emerging market sovereign bonds versus US governmental securities. The proposed methodology derives important insights for practical strategies of managing interest rate risk in the banking book. We find that the direct positive interest rate sensitivity under normal economic conditions is interchanged with the inverted negative sensitivity during distressed crisis-affected market turbulences. Due to the time-varying behavior of interest rate sensitivity, the hedging of interest rate risk must be a dynamic process linked to phases of the business cycle.