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Macro stress testing of credit risk focused on the tails

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  • Schechtman, Ricardo
  • Gaglianone, Wagner Piazza

Abstract

This paper investigates macro stress testing of system-wide credit risk with special focus on the tails of the credit risk distributions conditional on adverse macroeconomic scenarios. These tails determine the ex-post solvency probabilities derived from the scenarios. This paper estimates the macro-credit risk link by the traditional Wilson (1997a,b) model as well as by an alternative proposed quantile regression (QR) method (Koenker and Xiao, 2002), in which the relative importance of the macro variables can vary along the credit risk distribution, conceptually incorporating uncertainty in default correlations. Stress-testing exercises on the Brazilian household sector at the one-quarter horizon indicate that unemployment rate distress produces the most harmful effect, whereas distressed inflation and distressed interest rate show higher impacts at longer periods. Determining which of the two stress-testing approaches perceives the scenarios more severely depends on the type of comparison employed. The QR approach is revealed more conservative based on a suggested comparison of vertical distances between the tails of the conditional and unconditional credit risk cumulative distributions.

Suggested Citation

  • Schechtman, Ricardo & Gaglianone, Wagner Piazza, 2012. "Macro stress testing of credit risk focused on the tails," Journal of Financial Stability, Elsevier, vol. 8(3), pages 174-192.
    • Handle: RePEc:eee:finsta:v:8:y:2012:i:3:p:174-192
    DOI: 10.1016/j.jfs.2011.10.003
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    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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