Deconstructing systemic risk: A reverse stress testing approach

The financial sector faces different systemic events. The early recognition of these events is a key step to monitor and track possible financial crises. Three main questions arise related to systemic risk, and they deal with their quantification, their probability of occurrence and the role of main contributors. This paper proposes a methodology based on a reverse stress test exercise to shed light on these questions. Time series and cross-section information regarding systemic risk are obtained. Further, an assessment of how these results of systemic assessment could change depending on key parameters in a Gaussian framework is undertaken and, finally, a small empirical exercise is performed.