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Evaluation of Default Risk for the Brazilian Banking Sector

by Marcelo Y. Takami of Banco Central do Brasil, and
Benjamin M. Tabak of Banco Central do Brasil

May 2007

Abstract: This paper employs new methods to measure and monitor risk in the Brazilian banking sector. We prove that the option-based risk measure is negatively sensitive to interest rates. As this is an important issue for emerging market economies, the risk measures are built as deviations from mean. Additionally, the option-based indicator is compared with market-based financial fragility indicators. Results show that these indicators are useful for risk managers and regulators, especially during crisis. Furthermore, option-based methods are preferable to classify banks in periods of high distress, such as the banking crises that occurred in the early nineties in Brazil.

JEL Classification: G21.

Keywords: financial institutions, distance to default, systematic risk, financial stability.

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