Macroprudential stress tests: a reduced-form approach to quantifying systemic risk losses

Zineddine Alla, Raphael Espinoza, Helen Li and Miguel Segoviano

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We present a novel approach that incorporates individual entity stress testing and losses from systemic risk effects (SE losses) into macroprudential stress testing. SE losses are measured using a reduced-form model to value financial entity assets, conditional on macroeconomic stress and the distress of other entities in the system. This valuation is made possible by a multivariate density which characterizes the asset values of the financial entities making up the system. In this paper this density is estimated using CIMDO, a statistical approach, which infers densities that are consistent with entities' probabilities of default, which in this case are estimated using market-based data. Hence, SE losses capture the effects of interconnectedness structures that are consistent with markets' perceptions of risk. We then show how SE losses can be decomposed into the likelihood of distress and the magnitude of losses, thereby quantifying the contribution of specific entities to systemic contagion. To illustrate the approach, we quantify SE losses due to Lehman Brothers' default.

Keywords: stress testing; systemic risk; financial stability (search for similar items in EconPapers)
JEL-codes: E44 G00 G28 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2018-07-06
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://eprints.lse.ac.uk/118930/ Open access version. (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:118930

Access Statistics for this paper

More papers in LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library LSE Library Portugal Street London, WC2A 2HD, U.K.. Contact information at EDIRC.
Bibliographic data for series maintained by LSERO Manager ().