Market-Implied Systemic Risk in a Banking System

The Bank of England measures systemic risk within a banking system based on market-implied expected losses. Ken Deeley of MathWorks presents joint work with Somnath Chatterjee of the Centre for Central Banking Studies at the Bank of England using a structural credit risk model. The model, developed using MATLAB^® and Financial Toolbox™, is based on a jump diffusion process, which defines the probability of default based on the risk-adjusted balance sheet of banks whose assets are stochastic and may be above or below promised payments on its debt obligations. Using this framework, they estimate implied asset values and expected losses of individual banks. They then develop a model to estimate the joint-default risk of multiple banks falling into distress as a portfolio of individual market-implied expected losses using generalized extreme value (GEV) analysis and a multivariate copula as a dependence measure.