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Stress testing with multiple scenarios: a tale on tails and reverse stress scenarios

Author

Listed:
  • Aikman, David
  • Angotti, Romain
  • Budnik, Katarzyna

Abstract

This paper proposes an operational approach to stress testing, allowing one to assess the banking sector’s vulnerability in multiple plausible macro-financial scenarios. The approach helps identify macro-financial risk factors of particular relevance for the banking system and individual banks and searches for scenarios that could push them towards their worst outcomes. We demonstrate this concept using a macroprudential stress testing model for the euro area. By doing so, we show how multiple-scenario stress testing can complement single-scenario stress tests, aid in scenario design, and evaluate risks in the banking system. We also show how stress tests and scenarios can be optimized to accommodate different mandates and instruments of supervisory and macroprudential agencies. JEL Classification: E37, E58, G21, G28

Suggested Citation

  • Aikman, David & Angotti, Romain & Budnik, Katarzyna, 2024. "Stress testing with multiple scenarios: a tale on tails and reverse stress scenarios," Working Paper Series 2941, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20242941
    Note: 1355359
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    References listed on IDEAS

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    1. Budnik, Katarzyna, 2019. "A bird’s-eye view of the resilience of the European banking system: results from the new macroprudential stress test framework," Macroprudential Bulletin, European Central Bank, vol. 7.
    2. Pliszka, Kamil, 2021. "System-wide and banks' internal stress tests: Regulatory requirements and literature review," Discussion Papers 19/2021, Deutsche Bundesbank.
    3. 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.
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    9. Peter Grundke & Kamil Pliszka, 2018. "A macroeconomic reverse stress test," Review of Quantitative Finance and Accounting, Springer, vol. 50(4), pages 1093-1130, May.
    10. Budnik, Katarzyna & Groß, Johannes & Vagliano, Gianluca & Dimitrov, Ivan & Lampe, Max & Panos, Jiri & Velasco, Sofia & Boucherie, Louis & Jančoková, Martina, 2023. "BEAST: A model for the assessment of system-wide risks and macroprudential policies," Working Paper Series 2855, European Central Bank.
    11. Martin Cihak, 2004. "Stress Testing: A Review of Key Concepts," Research and Policy Notes 2004/02, Czech National Bank, Research and Statistics Department.
    12. Borio, Claudio & Drehmann, Mathias & Tsatsaronis, Kostas, 2014. "Stress-testing macro stress testing: Does it live up to expectations?," Journal of Financial Stability, Elsevier, vol. 12(C), pages 3-15.
    13. Thomas Breuer & Imre Csiszár, 2016. "Measuring Distribution Model Risk," Mathematical Finance, Wiley Blackwell, vol. 26(2), pages 395-411, April.
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    Cited by:

    1. Masoud Soleimani, 2025. "LLM-Generated Counterfactual Stress Scenarios for Portfolio Risk Simulation via Hybrid Prompt-RAG Pipeline," Papers 2512.07867, arXiv.org.
    2. Bro de Comères, Quentin & Mugrabi, Farah & Lyons, Paul, 2025. "A Quick Stress Testing Methodology for Irish Banks," Research Technical Papers 17/RT/25, Central Bank of Ireland.
    3. 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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    Keywords

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    JEL classification:

    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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