Typology for flight-to-quality episodes and downside risk measurement

Abstract

We 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.

Interest rate, liquidity, and sovereign risk: derivative-based VaR

“…To highlight a necessity of the joint risk consideration, much of recent academic research turns to analyzing interdependence between these two risk categories, namely, CR and IRR (Drehmann et al, 2010;Hartmann, 2010;Gubareva and Borges, 2016;among others). Interaction between CR and IRR categories has already attracted considerable attention (Kiesel et al, 2002;Tang and Yan, 2010).…”

Rethinking economic capital management through the integrated derivative-based treatment of interest rate and credit risk

“…Such CR spreads and interest rates dynamics took place during the recent financial crisis, when interest rates dropped and simultaneously the average creditworthiness of debt issuers, being banks, corporates or sovereigns, deteriorated too. Gubareva (2014) and Gubareva and Borges (2016a) argue that it is not an exceptional case but rather common and expectable circumstances, as crashes and recessions usually always coincide with downward tendency in interest rates dynamics.…”

“…The interaction of these risks is assessed within the flight-to-quality time windows linked to the business cycle and also over the periods of recovery from flights-to-quality. Thus, in this manner we also contribute to the research dedicated to flight-to-quality phenomena, when capital flies from risky to risk-free assets, augmenting credit risk spreads of the former and diminishing the yields of the latter (Gubareva 2014;Fuerst et al 2015;Gubareva and Borges 2016a).…”

Binary interest rate sensitivities of emerging market corporate bonds

“…Not surprisingly, there is a growing volume of scientific research addressing the effects of interest rate changes on bank performance and solvency. See, for example, Berends et al (2013), Neal et al (2015), Dupoyet, Jiang, and Zhang (2016), Gubareva and Borges (2016), Gubareva and Borges (2017), and references therein.…”