Stress Testing in a Structural Model of Bank Behavior

We develop a structural banking model for microprudential stress testing. We model a single bank that optimally chooses portfolio allocation, dividend policy and exit, facing regulatory and technological constraints. In our calibrated model, the bank has an incentive to hold a buffer stock of capital even in excess of regulatory requirements to protect its charter value. We explore optimal behavior during severe macroeconomic stress. We employ bank’s endogenous exit choice as a novel metric for counterfactual stress outcomes. Finally, we discuss implications for current stress testing framework.