A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing

Christian Schmieder, Tidiane Kinda, Nassim Taleb, Elena Loukoianova () and Elie Canetti

No 2012/216, IMF Working Papers from International Monetary Fund

Abstract: This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.

Keywords: WP; procedure; debt; bank; bank capitalization; Stress Testing; Forecasting; Stability; tail risk; contagion risk stress tests; inappropriate method; interconnectivity risk; standardized method; basic procedure; Personal income; Credit; Solvency stress testing; Global (search for similar items in EconPapers)
Pages: 24
Date: 2012-08-01
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Citations: View citations in EconPapers (19)

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