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A systematic approach to multi-period stress testing of portfolio credit risk

Thomas Breuer, Martin Jandačka, Javier Mencia () and Martin Summer ()

Journal of Banking & Finance, 2012, vol. 36, issue 2, 332-340

Abstract: We propose a new method for analysing multi-period stress scenarios for portfolio credit risk more systematically than in current macro stress tests. The plausibility of a scenario is quantified by its distance from an average scenario. For a given level of plausibility, we search systematically for the most adverse scenario. This ensures that no plausible scenario will be missed. We show how this method can be applied to some models already in use by practitioners. While worst case search requires numerical optimisation we show that we can work with reasonably good linear approximations to the portfolio loss function. This makes systematic multi-period stress testing computationally efficient and easy to implement. Applying our approach to data from the Spanish loan register we show that, compared to standard stress test procedures, our method identifies more harmful scenarios that are equally plausible.

Keywords: Stress testing; Credit risk; Worst case search; Maximum loss (search for similar items in EconPapers)
JEL-codes: G28 G32 G20 C15 (search for similar items in EconPapers)
Date: 2012
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Working Paper: A systematic approach to multi-period stress testing of portfolio credit risk (2010) Downloads
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Handle: RePEc:eee:jbfina:v:36:y:2012:i:2:p:332-340