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How big should a Stress Shock be?

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  • David G Maher

Abstract

Stress shocks are often calculated as multiples of the standard deviation of a history set. This paper investigates how many standard deviations are required to guarantee that this shock exceeds any observation within the history set, given the additional constraint of kurtosis. The results of this analysis are then used to validate the shocks produced by some stress test models, in particular that of Brace-Lauer-Rado. A secondary application of our results is to investigate three known extensions of Chebyshev's Inequality where the kurtosis is known. It is found that our results give a tighter bound than the well-known inequalities.

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  • David G Maher, 2019. "How big should a Stress Shock be?," Papers 1905.10164, arXiv.org.
    • Handle: RePEc:arx:papers:1905.10164
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    1. Eckhard Platen & Renata Rendek, 2007. "Empirical Evidence on Student-t Log-Returns of Diversified World Stock Indices," Research Paper Series 194, Quantitative Finance Research Centre, University of Technology, Sydney.
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    3. Scott, Louis O., 1987. "Option Pricing when the Variance Changes Randomly: Theory, Estimation, and an Application," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(4), pages 419-438, December.
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