Are stress tests beauty contests? (and what we can do about it)

Mario Quagliariello

Journal of Risk Management in Financial Institutions, 2020, vol. 13, issue 2, 126-134

Abstract: There is increasing debate on whether official-sector stress tests are fit for purpose and deliver what they are designed for. In the European Union, this discussion focuses not only on the costs and benefits of such a large-scale bottom-up exercise and on the possible options to improve its usefulness for banks, supervisors and the general public, but also on exploring ways to make it less burdensome. This paper discusses whether some improvements to the design of the EU-wide stress test could better align the incentives of the different stakeholders involved. In particular, the objective is to understand whether there is room for mitigating the beauty contest problem, namely the problem that banks are more interested in showing that they are outperforming others than in identifying actual risks in an adverse scenario.

Keywords: stress test; bank; European Banking Authority; supervision; beauty contest; incentives (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:aza:rmfi00:y:2020:v:13:i:2:p:126-134

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