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Introduction to Applied Stress Testing

Author

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  • Martin Cihak

Abstract

Stress testing is a useful and increasingly popular, yet sometimes misunderstood, method of analyzing the resilience of financial systems to adverse events. This paper aims to help demystify stress tests, and illustrate their strengths and weaknesses. Using an Excel-based exercise with institution-by-institution data, readers are walked through stress testing for credit risk, interest rate and exchange rate risks, liquidity risk and contagion risk, and are guided in the design of stress testing scenarios. The paper also describes the links between stress testing and other analytical tools, such as financial soundness indicators and supervisory early warning systems. Furthermore, it includes surveys of stress testing practices in central banks and the IMF.

Suggested Citation

  • Martin Cihak, 2007. "Introduction to Applied Stress Testing," IMF Working Papers 07/59, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:07/59
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    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=20222
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    References listed on IDEAS

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    1. Ivan Baboucek & Martin Jancar, 2005. "Effects of Macroeconomic Shocks to the Quality of the Aggregate Loan Portfolio," Working Papers 2005/01, Czech National Bank, Research Department.
    2. Andrew D. Crockett, 1997. "Why is financial stability a goal of public policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 5-22.
    3. Bank for International Settlements, 2005. "Stress testing at major financial institutions: survey results and practice," CGFS Papers, Bank for International Settlements, number 24.
    4. Andrew D. Crockett, 1997. "Why is financial stability a goal of public policy?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 7-36.
    5. Glenn Hoggarth & Andrew Logan & Lea Zicchino, 2005. "Macro stress tests of UK banks," BIS Papers chapters,in: Bank for International Settlements (ed.), Investigating the relationship between the financial and real economy, volume 22, pages 392-408 Bank for International Settlements.
    6. Snorre Evjen & Arild J Lund & Kjersti Haare Morka & Kjell B Nordal & Ingvild Svendsen, 2005. "Monetary and financial stability in Norway: what can we learn from macroeconomic stress tests?," BIS Papers chapters,in: Bank for International Settlements (ed.), Investigating the relationship between the financial and real economy, volume 22, pages 409-30 Bank for International Settlements.
    7. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Risk Assessment for Banking Systems," Management Science, INFORMS, vol. 52(9), pages 1301-1314, September.
    8. Kexue Liu & Jean Salvati & Renzo G Avesani & Alin T Mirestean, 2006. "Review and Implementation of Credit Risk Models of the Financial Sector Assessment Program (FSAP)," IMF Working Papers 06/134, International Monetary Fund.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Covas, Francisco B. & Rump, Ben & Zakrajšek, Egon, 2014. "Stress-testing US bank holding companies: A dynamic panel quantile regression approach," International Journal of Forecasting, Elsevier, vol. 30(3), pages 691-713.
    2. repec:kap:apfinm:v:24:y:2017:i:3:d:10.1007_s10690-017-9229-y is not listed on IDEAS
    3. Darne, O. & Levy-Rueff, O. & Pop, A., 2013. "Calibrating Initial Shocks in Bank Stress Test Scenarios: An Outlier Detection Based Approach," Working papers 426, Banque de France.
    4. repec:onb:oenbwp:y::i:150:b:1 is not listed on IDEAS
    5. Rupert D Worrell, 2008. "Stressing to Breaking Point; Interpreting Stress Test Results," IMF Working Papers 08/148, International Monetary Fund.
    6. Mizuho Kida, 2008. "A macro stress testing model with feedback effects," Reserve Bank of New Zealand Discussion Paper Series DP2008/08, Reserve Bank of New Zealand.
    7. Nguenang, Christian & Kamgna, Sévérin yves & Tinang, Nzeusseu Jules, 2010. "Une approche Macroprudentielle du risque systémique en zone CEMAC
      [A Macro-prudential approach of systemic risk in CEMAC zone]
      ," MPRA Paper 25632, University Library of Munich, Germany.
    8. Natasa Erjavec & Boris Cota & Sasa Jaksic, 2012. "Sign restriction approach to macro stress-testing of the Croatian banking system," Financial Theory and Practice, Institute of Public Finance, vol. 36(4), pages 395-412.
    9. 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.
    10. repec:eee:jpolmo:v:40:y:2018:i:2:p:452-475 is not listed on IDEAS
    11. Rasmus Kattai, 2010. "Credit risk model for the Estonian banking sector," Bank of Estonia Working Papers wp2010-01, Bank of Estonia, revised 04 Feb 2010.

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