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How to find plausible, severe, and useful stress scenarios

Author

Listed:
  • Thomas Breuer

    (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.)

  • Martin Jandacka

    (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.)

  • Klaus Rheinberger

    (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.)

  • Martin Summer

    (Oesterreichische Nationalbank, Economic Studies Division)

Abstract

We give a precise operational definition to three requirements the Basel Committee on Banking Supervision specifies for stress tests: Plausibility and severity of stress scenarios as well as suggestiveness of risk reducing actions. The basic idea of our approach is to define a suitable region of plausibility in terms of the risk factor distribution and search systematically for the worst portfolio loss over this region. One key innovation compared to the existing literature is the solution of two open problems. We suggest a measure of plausibility that is not prone to the problem of dimensional dependence of maximum loss and we derive a way to consistently deal with situations where some but not all risk factors are stressed. Among the various approaches used for partial scenarios, plausibility is maximised by setting the non stressed risk factors to their conditional expected value given the value of the stressed risk factors.

Suggested Citation

  • Thomas Breuer & Martin Jandacka & Klaus Rheinberger & Martin Summer, 2009. "How to find plausible, severe, and useful stress scenarios," Working Papers 150, Oesterreichische Nationalbank (Austrian Central Bank).
    • Handle: RePEc:onb:oenbwp:150
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    References listed on IDEAS

    as
    1. M. Hashem Pesaran & L. Vanessa Smith & Ron P. Smith, 2005. "What if the UK had Joined the Euro in 1999? An Empirical Evaluation Using a Global VAR," CESifo Working Paper Series 1477, CESifo.
    2. Filippo di Mauro & L. Vanessa Smith & Stephane Dees & M. Hashem Pesaran, 2007. "Exploring the international linkages of the euro area: a global VAR analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 1-38.
    3. M. Hashem Pesaran & Til Schuermann & Bjorn-Jakob Treutler, 2007. "Global Business Cycles and Credit Risk," NBER Chapters, in: The Risks of Financial Institutions, pages 419-469, National Bureau of Economic Research, Inc.
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    More about this item

    Keywords

    Stress testing; maximum loss; risk management; banking regulation.;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General

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