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A formalized, integrated and visual approach to stress testing

Alexander Denev () and Yaacov Mutnikas ()
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Alexander Denev: IHS Markit
Yaacov Mutnikas: IHS Markit

Risk Management, 2016, vol. 18, issue 4, 189-216

Abstract: Abstract In this paper, we will give for the first time a formal mathematical language to the steps used currently by financial institutions when calculating the impact of a stress scenario on a balance sheet that depends on more granular or different factors than those provided in the scenario. We will introduce the language of Probabilistic Graphical Models – a technique rooted in machine learning – to show how the different models used at each step can be put together in a coherent picture, thus giving a holistic view of the entire model setup. This will give us a solid basis to discuss some weaknesses and problems with the stress-testing exercises run by the industry as of today. We will show empirical analyses to substantiate better some of our claims.

Keywords: stress testing; scenario analysis; integrated risk management; probabilistic graphical models; visualization (search for similar items in EconPapers)
Date: 2016
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