Systematic stress tests with entropic plausibility constraints

Thomas Breuer and Imre Csiszár

Journal of Banking & Finance, 2013, vol. 37, issue 5, 1552-1559

Abstract: Stress tests with handpicked scenarios might misrepresent risks either because dangerous scenarios are not considered or because the scenarios considered are too implausible. To overcome these two pitfalls we propose a systematic search for the worst case within a relative entropy ball of sufficiently plausible scenarios. For this purpose we use mixed scenarios, which are risk factor distributions rather than realisations. A Maximum Loss theorem explicitly gives the worst case distribution. The method is illustrated in a number of example applications: linear and quadratic portfolios, stressed default probabilities, stressed correlations, macroeconomic stress tests.

Keywords: Scenario analysis; Worst case; Risk measures; Multiple priors; Model risk; Relative entropy (search for similar items in EconPapers)
JEL-codes: C18 C44 C60 G01 G32 M48 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (42)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:5:p:1552-1559

DOI: 10.1016/j.jbankfin.2012.04.013

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