Stress Testing Models: A Strategic Risk Management Tool

Balvinder Sangha () and Jane Lin ()
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Balvinder Sangha: Ernst & Young LLP, Postal: 8484 Westpark Drive, McLean, VA 22102
Jane Lin: Ernst & Young LLP, Postal: 5 Times Square, New York, NY 10036

Journal of Financial Perspectives, 2013, vol. 1, issue 2, 81-89

Abstract: This paper discusses the role of models in conducting stress-tests for regulatory and risk management purposes, and presents some approaches that may enhance their ability to estimate outcomes in a stressful environment. Unlike a conventional model that is designed for a steady state environment, we argue that a stress-testing model needs to be developed with a different design to capture the implications of abnormal business and economic conditions. Developing such a model may require a combination of qualitative and quantitative adjustments to capture the stress or boundary conditions. Consequently, the governance needs of stress-testing models require more rigor than steady state models to effectively challenge the underlying construct and assumptions. It is critical that senior management appreciate these nuances before using the output of such models for key strategic decisions.

Keywords: stres testing; banking; financial crisis (search for similar items in EconPapers)
JEL-codes: E51 G21 (search for similar items in EconPapers)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:ris:jofipe:0017

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