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A New Heuristic Measure of Fragility and Tail Risks

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Author Info

  • Christian Schmieder
  • Tidiane Kinda
  • Nassim N. Taleb
  • Elena Loukoianova
  • Elie Canetti

Abstract

This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/216.

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Length: 24
Date of creation: 01 Aug 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/216

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Related research

Keywords: Stress testing; Banks; Economic models; Public debt; debt dynamics; sovereign debt; net debt; banking; bank capitalization; public finances; liquidity crises; debt ratios; retained earnings; highly indebted countries; banks ? loan; debt crisis; bank funding; banking distress; bank data; financial risk; budget balances; value at risk model; indebted countries; banking system; stock of debt; bank capital; recapitalization; liquidity crisis; bank governors; interbank market; central bank; banking supervisor; sovereign debt crisis; debt dynamic; bank losses;

This paper has been announced in the following NEP Reports:

References

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  1. Bayoumi, Tamim & Vitek, Francis, 2011. "Spillovers from the Euro Area Sovereign Debt Crisis: A Macroeconometric Model Based Analysis," CEPR Discussion Papers 8497, C.E.P.R. Discussion Papers.
  2. Christian Schmieder & Maher Hasan & Claus Puhr, 2011. "Next Generation Balance Sheet Stress Testing," IMF Working Papers 11/83, International Monetary Fund.
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Citations

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Cited by:
  1. Robert M. Heath, 2013. "Why are the G-20 Data Gaps Initiative and the SDDS Plus Relevant for Financial Stability Analysis?," IMF Working Papers 13/6, International Monetary Fund.
  2. Daniel C. Hardy & Christian Schmieder, 2013. "Rules of Thumb for Bank Solvency Stress Testing," IMF Working Papers 13/232, International Monetary Fund.
  3. J. D. Opdyke, 2014. "Estimating Operational Risk Capital with Greater Accuracy, Precision, and Robustness," Papers 1406.0389, arXiv.org, revised Jul 2014.
  4. Eugenio Cerutti & Christian Schmieder, 2012. "The Need for "Un-consolidating" Consolidated Banks' Stress Tests," IMF Working Papers 12/288, International Monetary Fund.

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