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Robust Stress Testing

Author

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  • Andrew McKenna

    (Federal Reserve Bank of San Francisco)

  • Rhys Bidder

    (Federal Reserve Bank of San Francisco)

Abstract

We first carry out our analysis in the familiar Linear-Quadratic framework of Hansen and Sargent (2008), based on an estimated VAR for the economy and linear regressions of bank performance on the state of the economy. We note, however that the worst case so constructed features undesirable properties for our purpose in that it distorts moments that we would prefer were left undistorted. In response, we make a contribution to robustness theory within economics by formulating a finite horizon robust forecasting problem in which the worst case distribution is required to respect certain moment conditions. In this framework, we are able to allow for rich nonlinearities in the benchmark process and more general loss functions than in the L-Q setup, thereby bring our approach closer to applied use.

Suggested Citation

  • Andrew McKenna & Rhys Bidder, 2014. "Robust Stress Testing," 2014 Meeting Papers 853, Society for Economic Dynamics.
  • Handle: RePEc:red:sed014:853
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    References listed on IDEAS

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    Cited by:

    1. Pierluigi Bologna & Anatoli Segura, 2017. "Integrating Stress Tests within the Basel III Capital Framework: A Macroprudentially Coherent Approach," Journal of Financial Regulation, Oxford University Press, vol. 3(2), pages 159-186.
    2. Michael Jacobs, 2016. "Stress Testing and a Comparison of Alternative Methodologies for Scenario Generation," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 6(6), pages 1-7.
    3. Pritsker, Matt, 2019. "An overview of regulatory stress-testing and steps to improve it," Global Finance Journal, Elsevier, vol. 39(C), pages 39-43.

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