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A macro stress testing model with feedback effects

Stress testing is a tool to analyse the resilience of a financial system under extreme shocks. In contrast to single-bank stress testing models, macro stress testing models attempt to analyse risk for the system as a whole by taking into account feedback – i.e. the transmission of risks – within the system or between the financial system and the real economy. This paper develops a simple model of macro stress testing, incorporating two types of feedback: one between credit and interest rate risks and another between the banking system and the real economy. The model is tested using hypothetical banking sector data. The results from the exercise highlight the importance of incorporating feedback effects for the assessment of total risks to the system, and of recognising more than one type of feedback effect in a model for a robust assessment of risks to financial stability.

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File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2008/dp08_08.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2008/08.

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Length: 37 p.
Date of creation: May 2008
Date of revision:
Handle: RePEc:nzb:nzbdps:2008/08
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  1. Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A Time Series Analysis of Financial Fragility in the UK Banking System," OFRC Working Papers Series 2004fe18, Oxford Financial Research Centre.
  2. Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2003. "A Model to Analyse Financial Fragility," OFRC Working Papers Series 2003fe13, Oxford Financial Research Centre.
  3. Marco Sorge, 2004. "Stress-testing financial systems: an overview of current methodologies," BIS Working Papers 165, Bank for International Settlements.
  4. Martin Cihak & Jaroslav Hermanek, 2005. "Stress Testing the Czech Banking System: Where Are We? Where Are We Going?," Research and Policy Notes 2005/02, Czech National Bank, Research Department.
  5. Mathias Drehmann & Steffen Sorensen & Marco Stringa, 2007. "Integrating credit and interest rate risk: A theoretical framework and an application to banks' balance sheets," Money Macro and Finance (MMF) Research Group Conference 2006 151, Money Macro and Finance Research Group.
  6. Maria Soledad Martinez Peria & Giovanni Majnoni & Matthew T. Jones & Winfrid Blaschke, 2001. "Stress Testing of Financial Systems; An Overview of Issues, Methodologies, and FSAP Experiences," IMF Working Papers 01/88, International Monetary Fund.
  7. Martin Cihak, 2004. "Stress Testing: A Review of Key Concepts," Research and Policy Notes 2004/02, Czech National Bank, Research Department.
  8. Martin Cihák, 2007. "Introduction to Applied Stress Testing," IMF Working Papers 07/59, International Monetary Fund.
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