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Manoeuvring credit portfolios beyond Covid-19

Over the last months, we have been reminded that during times of heightened volatility or generic instability, markets have a tendency to run synchronously. As a consequence, assets become more correlated, even across different sectors. It was indeed striking to observe that in this respect the Covid-19 crisis even outpaced the global financial crisis from 2008.

The video below shows rolling windows of 1-year pairwise correlations of S&P sector indices, comparing them for the two crises: the crisis of 2008 and the current one.

Correlations can serve as a good measure to gauge the overall development of the larger market. We observe that during both crises multiple sectors start moving essentially in lockstep with correlations above 90%. However, the impact of the current crisis affected even more sectors in this respect and more sudden than the global financial crisis from 2008. In this crisis more than 10 pairs of sectors started moving synchronously!

How will the world look in the aftermath of the current crisis? Will markets continue to run synchronously for a longer while like they did after 2008–2009?

The just published Fed’s CCAR stress testing results for the US banking sector are still to be updated this year, asking banks to re-run parts of the stress tests with updated scenarios.

How can financial institutions react to this situation? How to update models in a market environment changing at an unprecedented speed?

When the Fed announced its CCAR scenarios for the 2020 stress testing exercise in February, they were largely outdated a month later and not just by small figures. Also input parameters to credit impairment and portfolio level models, can hardly be updated in a meaningful way under the standard approaches to react to the changing market environment and allow for stable planning.

How to differentiate between industries in scenarios that usually build on high-level macro-economic variables? How are they impacted by the crisis and governmental protective measures?

How do you approach manoeuvring your credit models and their calibration through and beyond Covid-19 ?

If your institution faces challenges with one or more of the above topics, we will be glad to share our expertise with you. Get in touch with us to receive more information: contact@sigmaqanalytics.com.

Written by

Independent specialist Lab focused on topics in Quantitative Analysis/Risk Management and Data Science. www.sigmaqanalytics.com

Independent specialist Lab focused on topics in Quantitative Analysis/Risk Management and Data Science. www.sigmaqanalytics.com

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