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How to Find Plausible, Severe and Useful Stress Scenarios

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  • Thomas Breuer

    (Research Centre PPE, Fachhochschule Vorarlberg)

  • Martin Jandacka

    (Research Centre PPE, Fachhochschule Vorarlberg)

  • Klaus Rheinberger

    (Research Centre PPE, Fachhochschule Vorarlberg)

  • Martin Summer

    (Oesterreichische Nationalbank)

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 scenario with the worst portfolio loss over this region. One key innovation compared with 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. We show that setting the nonstressed risk factors to their conditional expected value given the value of the stressed risk factors maximizes plausibility among the various approaches used in the literature.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 5 (2009)
Issue (Month): 3 (September)
Pages: 205-224

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Handle: RePEc:ijc:ijcjou:y:2009:q:3:a:7

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  1. 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.
  2. M. Hashem Pesaran & Til Schuermann & Björn-Jakob Treutler, 2005. "Global Business Cycles and Credit Risk," CESifo Working Paper Series 1548, CESifo Group Munich.
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