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Designing Stress Scenarios

Author

Listed:
  • CECILIA PARLATORE
  • THOMAS PHILIPPON

Abstract

We study the optimal design of stress scenarios. A principal manages the unknown risk exposures of agents by asking them to report losses under hypothetical scenarios before taking remedial actions. We apply a Kalman filter to solve the learning problem, and we relate the optimal design to the risk environment, the principal's preferences, and available interventions. In a banking context, optimal capital requirements cover losses under an adverse scenario, while targeted interventions depend on covariances among residual exposures and systematic risks. Our calibration reveals that information is particularly valuable for targeted interventions as opposed to broad capital requirements.

Suggested Citation

  • Cecilia Parlatore & Thomas Philippon, 2025. "Designing Stress Scenarios," Journal of Finance, American Finance Association, vol. 80(2), pages 833-873, April.
    • Handle: RePEc:bla:jfinan:v:80:y:2025:i:2:p:833-873
    DOI: 10.1111/jofi.13422
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    Cited by:

    1. is not listed on IDEAS
    2. Paul Glasserman & Mike Li, 2025. "Should Bank Stress Tests Be Fair?," Management Science, INFORMS, vol. 71(1), pages 262-278, January.
    3. Florin George Dragu, "undated". "Stress-Testing the Non-financial Companies' Sector," BASIQ Conference Proceedings 2024:071, Bucharest University of Economic Studies.
    4. Paul Glasserman & Mike Li, 2022. "Should Bank Stress Tests Be Fair?," Papers 2207.13319, arXiv.org, revised May 2023.
    5. Millossovich, Pietro & Tsanakas, Andreas & Wang, Ruodu, 2024. "A theory of multivariate stress testing," European Journal of Operational Research, Elsevier, vol. 318(3), pages 851-866.

    More about this item

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G2 - Financial Economics - - Financial Institutions and Services
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management

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