Further recipes for quantitative reverse stress testing

Grundke, Peter

doi:10.21314/jrmv.2012.089

Cited by 9 publications

(13 citation statements)

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“…Like Grundke (2011Grundke ( , 2012a, we assume a bank portfolio that exclusively consists of assets and liabilities structured as zero-coupon bonds. The bank pursues a strategy of positive maturity transformation implying negative net cash flows in the short term and positive net cash flows in the long term.…”

Section: Reverse Stress Testmentioning

confidence: 99%

“…3 See Grundke (2011Grundke ( , 2012a. 4 The mean and the standard deviation of the beta-distributed recovery rate equal Standard & Poor's mean and standard deviation of the recovery rate of senior unsecured bonds during 1987 to 2011 (see Standard & Poor's (2011b)).…”

Section: Reverse Stress Testmentioning

confidence: 99%

“…Employing ideas from integrated risk measurement, he calculates a bank's loss in economic value of equity using a CreditMetrics-based bottom-up model with correlated interest rates and rating-specific credit spreads. Later, in Grundke (2012a), this approach is expanded by more realistic assumptions, including, among other things, contagion effects between single obligors and a time-varying bank rating. Drüen and Florin (2010) argue in a vein similar to Grundke (2011), but they do not use a fully fledged bottom-up approach.…”

Section: Introductionmentioning

confidence: 99%

“…Our approach picks up ideas from the framework of Grundke (2011Grundke ( , 2012a. However, instead of performing pure simulation studies, we show how a quantitative reverse stress test can be implemented empirically using U.S. data.…”

Section: Introductionmentioning

confidence: 99%

“…As in Grundke (2011Grundke ( , 2012a, a scenario ω is composed of realizations of systematic risk factors. It is classified as a reverse stress test scenario when the existing capital buffer B (defined as the initial market value V E (0) of the bank's equity) is consumed by a conditional decrease in the expected equity value at the risk horizon H and by the respective conditional economic capital requirement.…”

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confidence: 99%

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A macroeconomic reverse stress test

Grundke

Pliszka

2017

Rev Quant Finan Acc

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Reproduction permitted only if source is stated.ISBN 978-3-95729-185-1 (Printversion) Non-technical summary Research QuestionIn response to the financial crisis [2007][2008][2009], regulatory authorities have strengthened the importance of stress test methodologies and particularly emphasized the role of reverse stress tests. Reverse stress tests look exactly for those scenarios which lead to a very unfavorable event for a bank, for example, an equity-exhausting loss, a non-fulfillment of the capital adequacy requirements or illiquidity. More generally, scenarios shall be identified that lead to an outcome in which the bank's business plan becomes unviable and the bank insolvent. In this paper, we show how a fully-fledged macroeconomic reverse stress test for credit and interest rate risk can be implemented which is in line with the new regulatory requirements. ContributionThis paper contributes to the sparse quantitative reverse stress test literature and sketches a framework which allows to model interactions between different risk factors at the level of individual financial instruments and risk factors. The focus lies on the presentation of the calibration procedure and on a detailed discussion of practical implementation issues. ResultsWe search for the most likely scenario which exhausts the bank's equity. It turns out that this so-called reverse stress test scenario, which is given by a combination of macroeconomic variables, is economically reasonable for the assumed bank portfolio. In particular, for a bank which engages in maturity-transformation, the most likely reverse stress test scenario implies a steeper interest rate curve and an economic downturn. However, the paper also reveals that due to high data requirements and intensive computational efforts, reverse stress tests are exposed to considerable model and estimation risk which makes numerous robustness checks necessary. AbstractReverse stress tests are a relatively new stress test instrument that aims at finding exactly those scenarios that cause a bank to cross the frontier between survival and default. Afterward, the scenario which is most probable has to be identified. This paper sketches a framework for a quantitative reverse stress test for maturity-transforming banks that are exposed to credit and interest rate risk and demonstrates how the model can be calibrated empirically. The main features of the proposed framework are: 1) The necessary steps of a reverse stress test (solving an inversion problem and computing the scenario probabilities) can be performed within one model, 2) Scenarios are characterized by realizations of macroeconomic risk factors, 3) Principal component analysis helps to reduce the dimensionality of the space of systematic risk factors, 4) Due to data limitations, the results of reverse stress tests are exposed to considerable model and estimation risk, which makes numerous robustness checks necessary.Keywords: copula functions, extreme value theory, principal component analysis, reverse stress testing JEL classi...

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Section: Reverse Stress Testmentioning

confidence: 99%

Section: Reverse Stress Testmentioning

confidence: 99%