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A formalized, integrated and visual approach to stress testing

Author

Listed:
  • Alexander Denev

    (IHS Markit)

  • Yaacov Mutnikas

    (IHS Markit)

Abstract

In this paper, we will give for the first time a formal mathematical language to the steps used currently by financial institutions when calculating the impact of a stress scenario on a balance sheet that depends on more granular or different factors than those provided in the scenario. We will introduce the language of Probabilistic Graphical Models – a technique rooted in machine learning – to show how the different models used at each step can be put together in a coherent picture, thus giving a holistic view of the entire model setup. This will give us a solid basis to discuss some weaknesses and problems with the stress-testing exercises run by the industry as of today. We will show empirical analyses to substantiate better some of our claims.

Suggested Citation

  • Alexander Denev & Yaacov Mutnikas, 2016. "A formalized, integrated and visual approach to stress testing," Risk Management, Palgrave Macmillan, vol. 18(4), pages 189-216, December.
    • Handle: RePEc:pal:risman:v:18:y:2016:i:4:d:10.1057_s41283-016-0009-1
    DOI: 10.1057/s41283-016-0009-1
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    References listed on IDEAS

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    1. Edward I. Altman & Andrea Resti & Andrea Sironi, 2002. "The link between default and recovery rates: effects on the procyclicality of regulatory capital ratios," BIS Working Papers 113, Bank for International Settlements.
    2. Rebonato,Riccardo & Denev,Alexander, 2014. "Portfolio Management under Stress," Cambridge Books, Cambridge University Press, number 9781107048119.
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    Cited by:

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