Sovereign Bond Backed Securities: A VAR for VaR and Marginal Expected Shortfall Assessment

A recent proposal by Brunnermeier et al (2011, 2016) to create sovereign bond backed securities (SBSs) has been assessed in terms of the likely losses that different kinds of holders would suffer under historically plausible... [ view full abstract ]

A recent proposal by Brunnermeier et al (2011, 2016) to create sovereign bond backed securities (SBSs) has been assessed in terms of the likely losses that different kinds of holders would suffer under historically plausible correlated defaults. However, mark-to-market losses that may arise when there is uncertainty about defaults (or rising risks of self-fulfilling destablising dynamics) have not yet been assessed in the context of the tranching proposal. We use the VAR for VaR" method of White, Kim and Manganelli (2015) and the Marginal Expected Shortfall approach described in Brownlees and Engle (2012) to assess how ex ante exposures are affected under the SBS proposals. We find that the estimated yield on the senior tranche of the proposed SBS has minor tail risk exposure and that its yield dynamics are dominated by its ability to act as a hedge against movements in the yield on the junior bond. The junior bond ranks as somewhat more exposed to tail risks than Italian and Spanish bonds but it is otherwise well placed to compete with existing crisis-prone sovereigns. Overall, yields to maturity of the securitised bonds provide adequate compensation for their risks. In a sufficiently benign regulatory environment - given the higher liquidity, embedded leverage, diversification and hedging advantages of SBSs - both Junior and Senior SBSs should be of interest to investors with a variety of risk preference profiles.