A financially justifiable and practically implementable approach to coherent stress testing. Issue 5 (4th May 2019)

• Record Type: Journal Article
• Authors: Rebonato, Riccardo
• Is Part Of: Quantitative finance. Volume 19:Issue 5(2019)
• Page Start: 827
• Page End: 842
• Publication Date: 2019-05-04
• Subjects: Stress testing -- Scenario analysis -- Risk management -- Bayesian nets -- Factor models; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2018.1532103
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : We present an approach to stress testing that is both practically implementable and solidly rooted in well-established financial theory. We present our results in a Bayesian-net context, but the approach can be extended to different settings. We show (i) how the consistency and continuity conditions are satisfied; (ii) how the result of a scenario can be consistently cascaded from a small number of macrofinancial variables to the constituents of a granular portfolio; and (iii) how an approximate but robust estimate of the likelihood of a given scenario can be estimated. This is particularly important for regulatory and capital-adequacy applications.