Worst-case asset, default and survival time correlations

Steffi Höse and Stefan Huschens

Journal of Risk Model Validation

Abstract: ABSTRACT The asymptotic single risk factor model is a standard model in the banking industry and is also used in the regulatory framework. In the context of this model, higher correlations do not always lead to higher stress and increased economic capital. Using this fact, worst-case asset, default and survival time correlations less than one are identified, and the concept of the worst-case economic capital is introduced. These worst-case scenarios are important aspects of stress testing, as they build the most adverse stressed scenarios. In an example, the calculation of worst-case correlations and worst-case scenarios for the economic capital are illustrated.

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