Systematic Scenario Selection: Stress Testing and the Nature of Uncertainty

Mark Flood and George G. Korenko ()
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George G. Korenko: Edgeworth Economics

No 13-02, Working Papers from Office of Financial Research, US Department of the Treasury

Abstract: We present a technique for selecting multidimensional shock scenarios for use in financial stress testing. The methodology systematically enforces internal consistency among the shock dimensions by sampling points of arbitrary severity from a plausible joint probability distribution. The approach involves a grid search of sparse, well distributed, stress-test scenarios, which we regard as a middle ground between traditional stress testing and reverse stress testing. Choosing scenarios in this way reduces the danger of "blind spots" in stress testing. We suggest extensions to address the issues of non-monotonic loss functions and univariate shocks. We provide tested and commented source code in MATLAB.

Keywords: risk management; stress testing; maximum portfolio loss; elliptical distribution; value at risk; Knightian uncertainty (search for similar items in EconPapers)
Pages: 47 pages
Date: 2013-02-07
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Citations: View citations in EconPapers (8)

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Journal Article: Systematic scenario selection: stress testing and the nature of uncertainty (2015)
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