 A factor-model approach for correlation scenarios and correlation stress testingN. Packham and C.F. Woebbeking Journal of Banking & Finance, 2019, vol. 101, issue C, 92-103 Abstract: In 2012, JPMorgan accumulated a USD 6.2 billion loss on a credit derivatives portfolio, the so-called “London Whale”, partly as a consequence of de-correlations of non-perfectly correlated positions that were supposed to hedge each other. Motivated by this case, we devise a factor model for correlations that allows for scenario-based stress testing of correlations. We derive a number of analytical results related to a portfolio of homogeneous assets. Using the concept of Mahalanobis distance, we show how to identify adverse scenarios of correlation risk. In addition, we demonstrate how correlation and volatility stress tests can be combined. As an example, we apply the factor-model approach to the “London Whale” portfolio and determine the value-at-risk impact from correlation changes. Since our findings are particularly relevant for large portfolios, where even small correlation changes can have a large impact, a further application would be to stress test portfolios of central counterparties, which are of systemically relevant size. Keywords: Correlation stress testing; Scenario selection; Market risk; “London Whale” (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:101:y:2019:i:c:p:92-103 DOI: 10.1016/j.jbankfin.2019.01.020 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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