How to Find Plausible, Severe and Useful Stress Scenarios
We give a precise operational definition to three requirements the Basel Committee on Banking Supervision specifies for stress tests: plausibility and severity of stress scenarios as well as suggestiveness of risk-reducing actions. The basic idea of our approach is to define a suitable region of plausibility in terms of the risk-factor distribution and search systematically for the scenario with the worst portfolio loss over this region. One key innovation compared with the existing literature is the solution of two open problems. We suggest a measure of plausibility that is not prone to the problem of dimensional dependence of maximum loss and we derive a way to consistently deal with situations where some but not all risk factors are stressed. We show that setting the nonstressed risk factors to their conditional expected value given the value of the stressed risk factors maximizes plausibility among the various approaches used in the literature.
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- Dées, Stéphane & di Mauro, Filippo & Pesaran, Hashem & Smith, Vanessa, 2005.
"Exploring the international linkages of the euro area: a global VAR analysis,"
Working Paper Series
0568, European Central Bank.
- Filippo di Mauro & L. Vanessa Smith & Stephane Dees & M. Hashem Pesaran, 2007. "Exploring the international linkages of the euro area: a global VAR analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 1-38.
- Dees, S. & di Mauro, F. & Pesaran, M.H. & Smith, L.V., 2005. "Exploring the International Linkages of the Euro Area: a Global VAR Analysis," Cambridge Working Papers in Economics 0518, Faculty of Economics, University of Cambridge.
- Stephane Dees & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2006. "Exploring the International Linkages of the Euro Area: a Global VAR Analysis," Computing in Economics and Finance 2006 47, Society for Computational Economics.
- Stephane Dees & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2004. "Exploring the International Linkages of the Euro Area: A Global VAR Analysis," IEPR Working Papers 04.6, Institute of Economic Policy Research (IEPR).
- Stephane Dees & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2005. "Exploring the International Linkages of the Euro Area: a Global VAR Analysis," CESifo Working Paper Series 1425, CESifo Group Munich.
- M. Hashem Pesaran & Til Schuermann & Björn-Jakob Treutler, 2005.
"Global Business Cycles and Credit Risk,"
NBER Working Papers
11493, National Bureau of Economic Research, Inc.
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