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A macro stress testing model with feedback effects

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Abstract

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.

Suggested Citation

  • 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.
    • Handle: RePEc:nzb:nzbdps:2008/08
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    1. John Whitley & Richard Windram & Prudence Cox, 2004. "An empirical model of household arrears," Bank of England working papers 214, Bank of England.
    2. Martin Cihak, 2004. "Stress Testing: A Review of Key Concepts," Research and Policy Notes 2004/02, Czech National Bank.
    3. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A model to analyse financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(1), pages 107-142, January.
    4. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A Time Series Analysis of Financial Fragility in the UK Banking System," Annals of Finance, Springer, vol. 2(1), pages 1-21, January.
    5. Marco Sorge, 2004. "Stress-testing financial systems: an overview of current methodologies," BIS Working Papers 165, Bank for International Settlements.
    6. Mr. Maria Soledad Martinez Peria & Mr. Giovanni Majnoni & Mr. Matthew T Jones & Mr. Winfrid Blaschke, 2001. "Stress Testing of Financial Systems: An Overview of Issues, Methodologies, and FSAP Experiences," IMF Working Papers 2001/088, International Monetary Fund.
    7. Mr. Martin Cihak, 2007. "Introduction to Applied Stress Testing," IMF Working Papers 2007/059, International Monetary Fund.
    8. 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.
    9. 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.
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    Cited by:

    1. Loser, Claudio M. & Kiguel, Miguel A. & Mermelstein, David, 2010. "A Macroprudential Framework for the Early Detection of Banking Problems in Emerging Economies," Working Papers on Regional Economic Integration 44, Asian Development Bank.
    2. Prasanna Gai, 2013. "Systemic risk measurement and macroprudential policy: Implications for New Zealand and beyond," New Zealand Economic Papers, Taylor & Francis Journals, vol. 47(1), pages 95-110, April.
    3. David A. Mermelstein, 2017. "Hacia un indicador de vulnerabilidad bancaria basado en pruebas de estrés," CEMA Working Papers: Serie Documentos de Trabajo. 610, Universidad del CEMA.

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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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