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Stress Testing Models: A Strategic Risk Management Tool

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  • Sangha, Balvinder

    ()
    (Ernst & Young LLP)

  • Lin, Jane

    ()
    (Ernst & Young LLP)

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    Abstract

    This paper discusses the role of models in conducting stress-tests for regulatory and risk management purposes, and presents some approaches that may enhance their ability to estimate outcomes in a stressful environment. Unlike a conventional model that is designed for a steady state environment, we argue that a stress-testing model needs to be developed with a different design to capture the implications of abnormal business and economic conditions. Developing such a model may require a combination of qualitative and quantitative adjustments to capture the stress or boundary conditions. Consequently, the governance needs of stress-testing models require more rigor than steady state models to effectively challenge the underlying construct and assumptions. It is critical that senior management appreciate these nuances before using the output of such models for key strategic decisions.

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    Bibliographic Info

    Article provided by EY Global FS Institute in its journal Journal of Financial Perspectives.

    Volume (Year): 1 (2013)
    Issue (Month): 2 ()
    Pages: 81-89

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    Handle: RePEc:ris:jofipe:0017

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    Related research

    Keywords: stres testing; banking; financial crisis;

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