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

Thomas Breuer (), Martin Jandačka (), Javier Mencia () and Martin Summer
Additional contact information
Thomas Breuer: Research Centre PPE
Martin Jandačka: Research Centre PPE

No 1018, Working Papers from Banco de España

Abstract: We propose a new method for analysing multiperiod stress scenarios for portfolio credit risk more systematically than in the current practice of macro stress testing. Our method quantifies the plausibility of scenarios by considering the distance of the stress scenario from an average scenario. For a given level of plausibility our method searches systematically for the most adverse scenario for the given portfolio. This method therefore gives a formal criterion for judging the plausibility of scenarios and it makes sure that no plausible scenario will be missed. We show how this method can be applied to a range of models already in use among stress testing practitioners. While worst case search requires numerical optimisation we show that for practically relevant cases we can work with reasonably good linear approximations to the portfolio loss function that make the method computationally very efficient and easy to implement. Applying our approach to data from the Spanish loan register and using a portfolio credit risk model 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: C15 G20 G28 G32 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2010-06
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-cmp, nep-fmk and nep-rmg
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: A systematic approach to multi-period stress testing of portfolio credit risk (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:1018

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