A systematic approach to multi-period stress testing of portfolio credit risk
AbstractWe propose a new method for analysing multi-period stress scenarios for portfolio credit risk more systematically than in current macro stress tests. The plausibility of a scenario is quantified by its distance from an average scenario. For a given level of plausibility, we search systematically for the most adverse scenario. This ensures that no plausible scenario will be missed. We show how this method can be applied to some models already in use by practitioners. While worst case search requires numerical optimisation we show that we can work with reasonably good linear approximations to the portfolio loss function. This makes systematic multi-period stress testing computationally efficient and easy to implement. Applying our approach to data from the Spanish loan register we show that, compared to standard stress test procedures, our method identifies more harmful scenarios that are equally plausible.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Banking & Finance.
Volume (Year): 36 (2012)
Issue (Month): 2 ()
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Web page: http://www.elsevier.com/locate/jbf
Stress testing; Credit risk; Worst case search; Maximum loss;
Other versions of this item:
- Thomas Breuer & Martin Jandačka & Javier Mencía & Martin Summer, 2010. "A systematic approach to multi-period stress testing of portfolio credit risk," Banco de Espaï¿½a Working Papers 1018, Banco de Espa�a.
- 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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