Positive Liquidity Spillovers from Sovereign Bond-Backed Securities

Abstract

This paper contributes to the debate concerning the benefits and disadvantages of introducing a European Sovereign Bond-Backed Securitisation (SBBS) to address the need for a common safe asset that would break destabilising bank-sovereign linkages. The analysis focuses on assessing the effectiveness of hedges incurred while making markets in individual euro area sovereign bonds by taking offsetting positions in one or more of the SBBS tranches. Tranche yields are estimated using a simulation approach. This involves the generation of sovereign defaults and allocation of the combined credit risk premium of all the sovereigns, at the end of each day, to the SBBS tranches according to the seniority of claims under the proposed securitisation. Optimal hedging with SBBS is found to reduce risk exposures substantially in normal market conditions. In volatile conditions, hedging is not very effective but leaves dealers exposed to mostly idiosyncratic risks. These remaining risks largely disappear if dealers are diversified in providing liquidity across country-specific secondary markets and SBBS tranches. Hedging each of the long positions in a portfolio of individual sovereigns results in a risk exposure as low as that borne by holding the safest individual sovereign bond (the Bund).

Current study on active flow control and passive flow control

“…The basic principle of active flow control is to control the direction, speed and stability of fluid flow by adjusting parameters such as fluid velocity, pressure, and temperature. The purpose of active flow control is to achieve precise control of fluid flow behavior to meet specific needs [3].…”

Computational Finance

“…The above contributions rely on having access to safe or risk free assets in combination with risky assets to generate sufficient cash flows. Dunne (2019) considers the benefits and disadvantages of introducing a European Sovereign Bond-Backed Securitisation (SBBS) to address the need for a common safe asset that would break destabilising bank-sovereign linkages. The author uses a simulation approach to assess the effectiveness of hedges incurred while making markets in individual euro area sovereign bonds by taking offsetting positions in one or more of the SBBS tranches.…”

“…This volume includes a wide variety of theoretical and empirical contributions that address a wide range of issues and topics related to computational finance. The published papers consider asset pricing in general with applications to bond pricing, see Dunne (2019), commodity modelling, see Cheng et al (2019), and derivatives pricing, see Létourneau and Stentoft (2019), Reesor and Marshall (2020) and Stentoft (2019); uses calibration techniques, see Van Dijk et al (2018); and considers issues related to hedging, see Dunne (2019). The published papers develop new multivariate models, see Cheng et al (2019), considers option pricing in this challenging setting, see Reesor and Marshall (2020), and addresses issues related to risk management, see Cheng et al (2019), Forsyth andVetzal (2019), andVan Dijk et al (2018).…”

“…The published papers develop new multivariate models, see Cheng et al (2019), considers option pricing in this challenging setting, see Reesor and Marshall (2020), and addresses issues related to risk management, see Cheng et al (2019), Forsyth andVetzal (2019), andVan Dijk et al (2018). The volume contains several papers that use simulation, see Dunne (2019), Létourneau and Stentoft (2019), Mukerji et al (2019), andStentoft (2019), and papers that provide new ways to model volatility, see Cheng et al (2019), and for estimating this, see Petrov et al (2019).…”