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Stress Testing Models: A Strategic Risk Management Tool

Author

Listed:
  • Sangha, Balvinder

    () (Ernst & Young LLP)

  • Lin, Jane

    () (Ernst & Young LLP)

Abstract

This paper discusses the role of models in conducting stress-tests for regulatory and risk management purposes, and presents some approaches that may enhance their ability to estimate outcomes in a stressful environment. Unlike a conventional model that is designed for a steady state environment, we argue that a stress-testing model needs to be developed with a different design to capture the implications of abnormal business and economic conditions. Developing such a model may require a combination of qualitative and quantitative adjustments to capture the stress or boundary conditions. Consequently, the governance needs of stress-testing models require more rigor than steady state models to effectively challenge the underlying construct and assumptions. It is critical that senior management appreciate these nuances before using the output of such models for key strategic decisions.

Suggested Citation

  • Sangha, Balvinder & Lin, Jane, 2013. "Stress Testing Models: A Strategic Risk Management Tool," Journal of Financial Perspectives, EY Global FS Institute, vol. 1(2), pages 81-89.
  • Handle: RePEc:ris:jofipe:0017
    as

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    More about this item

    Keywords

    stres testing; banking; financial crisis;

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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