Krishan Sharma of Citi argues that traditional risk models are structurally unfit for fast-moving geopolitical shocks. From regime-switching stress tests to Bayesian overlays and dynamic model maps, he outlines how firms must rethink calibration, connecti
Geopolitical shocks are exposing the
structural limits of traditional risk models built on historical stability and
linear assumptions, but one senior executive at a leading New York bank argues
that firms must shift toward adaptive, integrated, and sensitivity-driven
frameworks that capture velocity, regime shifts, and cross-risk amplification.
Krishan Sharma, a Senior VP Model
Risk - Regulatory Stress Testing and Capital Forecasting at Citi says only this
approach will enable organizations to move beyond prediction toward true
enterprise resilience.
“The fundamental issue is that our
traditional models, whether VaR, Expected Shortfall, or PD and LGD models, are
empirically calibrated,” he explains.
“They rely on the assumption of
stationarity – that the future statistical properties of a system will resemble
the past.”
That assumption collapses when
sanctions regimes are imposed overnight or supply chains fracture within weeks.
“Geopolitical shocks are, by
definition, structural breaks,” Sharma says. “A sudden sanction regime or a
blockade does not behave like a standard deviation move in a normal
distribution – it changes the distribution entirely.”
The result is a dangerous lag in
detection.
“Traditional models are rearview
mirror driven,” he notes. “When a geopolitical shock hits, the correlation
matrix often goes to one, and historical calibration windows fail to capture
the velocity of the transmission.
We are trying to model unknown
unknowns using a dataset of known knowns.”
In today’s environment of stagflation
risk, trade fragmentation, and policy volatility, Sharma believes stress
testing must evolve beyond linear degradation assumptions embedded in standard
regulatory exercises.
“We need to move beyond standard
regulatory exercises like CCAR or DFAST which often assume a linear degradation
of variables over nine quarters,” he says.
Instead, firms should focus on
velocity and persistence. He advocates regime-switching scenarios that
explicitly model relationship changes.
“In a stagflation scenario, the
typical negative correlation between equities and bonds might flip to positive,
nullifying diversification benefits,” he explains. That structural shift, not
just the magnitude of GDP decline, drives portfolio impact.
Reverse stress testing is another
critical tool. “Instead of asking what happens if rates rise 500 basis points,
ask what geopolitical event would break our liquidity position and work
backward,” Sharma recommends. He also warns against assuming stabilizing policy
responses.
“We need to stress test for policy
errors or volatility – where central bank reaction functions become
unpredictable or contradictory to fiscal policy.”
