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Quantitative reverse stress testing, bottom up

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  • Claudio Albanese
  • Stéphane Crépey
  • Stefano Iabichino

Abstract

We propose a bottom-up quantitative reverse stress testing framework that identifies forward-looking fragilities tailored to a bank's portfolio, credit and funding strategies, models, and calibration constraints. Thus, instead of relying on historical events, we run a Monte Carlo simulation, and we mine those future states that contribute the most to a bank's cost of capital expressed in terms of scenario differential. This approach allows identifying both the systemic and idiosyncratic weaknesses of the bank's portfolio, with applications that include solvency risk, extreme events hedging, liquidity risk management, trading and credit limits, model validation and model risk management.

Suggested Citation

  • Claudio Albanese & Stéphane Crépey & Stefano Iabichino, 2023. "Quantitative reverse stress testing, bottom up," Quantitative Finance, Taylor & Francis Journals, vol. 23(5), pages 863-875, May.
    • Handle: RePEc:taf:quantf:v:23:y:2023:i:5:p:863-875
    DOI: 10.1080/14697688.2023.2187315
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    Cited by:

    1. Cyril Bénézet & Stéphane Crépey, 2024. "Handling model risk with XVAs," Post-Print hal-03675291, HAL.
    2. Christophe Hurlin & Quentin Lajaunie & Yoann Pull, 2026. "Reverse Stress Testing Geopolitical Risk in Corporate Credit Portfolios: A Formal and Operational Framework," Papers 2601.03983, arXiv.org.

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