A systematic approach to multi-period stress testing of portfolio credit risk
We propose a new method for analysing multiperiod stress scenarios for portfolio credit risk more systematically than in the current practice of macro stress testing. Our method quantifies the plausibility of scenarios by considering the distance of the stress scenario from an average scenario. For a given level of plausibility our method searches systematically for the most adverse scenario for the given portfolio. This method therefore gives a formal criterion for judging the plausibility of scenarios and it makes sure that no plausible scenario will be missed. We show how this method can be applied to a range of models already in use among stress testing practitioners. While worst case search requires numerical optimisation we show that for practically relevant cases we can work with reasonably good linear approximations to the portfolio loss function that make the method computationally very efficient and easy to implement. Applying our approach to data from the Spanish loan register and using a portfolio credit risk model we show that, compared to standard stress test procedures, our method identifies more harmful scenarios that are equally plausible.
|Date of creation:||Jun 2010|
|Contact details of provider:|| Web page: http://www.bde.es/|
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Gordy, Michael B., 2003.
"A risk-factor model foundation for ratings-based bank capital rules,"
Journal of Financial Intermediation,
Elsevier, vol. 12(3), pages 199-232, July.
- Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.).
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
- Pesaran, M. Hashem & Schuermann, Til & Treutler, Bjorn-Jakob & Weiner, Scott M., 2006.
"Macroeconomic Dynamics and Credit Risk: A Global Perspective,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 38(5), pages 1211-1261, August.
- Pesaran, M.H. & Schuermann, T. & Treutler, B-J. & Weiner, S.M., 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," Cambridge Working Papers in Economics 0330, Faculty of Economics, University of Cambridge.
- M. Hashem Pesaran & Til Schuermann & Björn-Jakob Treutler & Scott M. Weiner & April, . "Macroeconomic Dynamics and Credit Risk: A Global Perspective," Center for Financial Institutions Working Papers 03-13, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Til Schuermann & Björn-Jakob Treutler & Scott M. Weiner & M. Hashem Pesaran, 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," CESifo Working Paper Series 995, CESifo Group Munich.
- Rodrigo Alfaro & Mathias Drehmann, 2009. "Macro stress tests and crises: what can we learn?," BIS Quarterly Review, Bank for International Settlements, December.
- Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
- Claudio Borio & Claudio Mathias Drehmann, 2009.
"Towards an operational framework for financial stability: "fuzzy" measurement and its consequences,"
BIS Working Papers
284, Bank for International Settlements.
- Claudio Borio & Mathias Drehmann, 2011. "Toward an Operational Framework for Financial Stability: “Fuzzy” Measurement and Its Consequences," Central Banking, Analysis, and Economic Policies Book Series, in: Rodrigo Alfaro (ed.), Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 4, pages 063-123 Central Bank of Chile.
- Claudio Borio & Mathias Drehmann, 2009. "Towards an Operational Framework for Financial Stability: "Fuzzy" Measurement and its Consequences," Working Papers Central Bank of Chile 544, Central Bank of Chile.
- Merton, Robert C., 1973.
"On the pricing of corporate debt: the risk structure of interest rates,"
684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
- Miroslav Misina & David Tessier & Shubhasis Dey, 2006. "Stress Testing the Corporate Loans Portfolio of the Canadian Banking Sector," Staff Working Papers 06-47, Bank of Canada.
- Thomas Breuer & Martin Jandacka & Klaus Rheinberger & Martin Summer, 2009.
"How to Find Plausible, Severe and Useful Stress Scenarios,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 5(3), pages 205-224, September.
- Thomas Breuer & Martin Jandacka & Klaus Rheinberger & Martin Summer, 2009. "How to find plausible, severe, and useful stress scenarios," Working Papers 150, Oesterreichische Nationalbank (Austrian Central Bank).
When requesting a correction, please mention this item's handle: RePEc:bde:wpaper:1018. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (María Beiro. Electronic Dissemination of Information Unit. Research Department. Banco de España)
If references are entirely missing, you can add them using this form.