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A macro stress testing model with feedback effects

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Abstract

Stress testing is a tool to analyse the resilience of a financial system under extreme shocks. In contrast to single-bank stress testing models, macro stress testing models attempt to analyse risk for the system as a whole by taking into account feedback – i.e. the transmission of risks – within the system or between the financial system and the real economy. This paper develops a simple model of macro stress testing, incorporating two types of feedback: one between credit and interest rate risks and another between the banking system and the real economy. The model is tested using hypothetical banking sector data. The results from the exercise highlight the importance of incorporating feedback effects for the assessment of total risks to the system, and of recognising more than one type of feedback effect in a model for a robust assessment of risks to financial stability.

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File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2008/dp08_08.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2008/08.

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Length: 37 p.
Date of creation: May 2008
Date of revision:
Handle: RePEc:nzb:nzbdps:2008/08

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  1. Dimitrios P Tsomocos, 2004. "A Time Series Analysis of Financial Fragility in the UK Banking System," Economics Series Working Papers, University of Oxford, Department of Economics 2004-FE-18, University of Oxford, Department of Economics.
  2. Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2003. "A Model to Analyse Financial Fragility," OFRC Working Papers Series, Oxford Financial Research Centre 2003fe13, Oxford Financial Research Centre.
  3. Mathias Drehmann & Steffen Sorensen & Marco Stringa, 2007. "Integrating credit and interest rate risk: A theoretical framework and an application to banks' balance sheets," Money Macro and Finance (MMF) Research Group Conference 2006, Money Macro and Finance Research Group 151, Money Macro and Finance Research Group.
  4. Martin Cihak, 2004. "Stress Testing: A Review of Key Concepts," Research and Policy Notes, Czech National Bank, Research Department 2004/02, Czech National Bank, Research Department.
  5. Marco Sorge, 2004. "Stress-testing financial systems: an overview of current methodologies," BIS Working Papers, Bank for International Settlements 165, Bank for International Settlements.
  6. Martin Cihak & Jaroslav Hermanek, 2005. "Stress Testing the Czech Banking System: Where Are We? Where Are We Going?," Research and Policy Notes, Czech National Bank, Research Department 2005/02, Czech National Bank, Research Department.
  7. Maria Soledad Martinez Peria & Giovanni Majnoni & Matthew T. Jones & Winfrid Blaschke, 2001. "Stress Testing of Financial Systems," IMF Working Papers, International Monetary Fund 01/88, International Monetary Fund.
  8. Martin Cihák, 2007. "Introduction to Applied Stress Testing," IMF Working Papers, International Monetary Fund 07/59, International Monetary Fund.
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Cited by:
  1. Loser, Claudio M. & Kiguel, Miguel A. & Mermelstein, David, 2010. "A Macroprudential Framework for the Early Detection of Banking Problems in Emerging Economies," Working Papers on Regional Economic Integration, Asian Development Bank 44, Asian Development Bank.

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