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A Coherent Aggregation Framework for Stress Testing and Scenario Analysis

Author

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  • Jan Kwiatkowski
  • Riccardo Rebonato

Abstract

We present a methodology to aggregate in a coherent manner conditional stress losses in a trading or banking book. The approach bypasses the specification of unconditional probabilities of the individual stress events and ensures by a linear programming approach so that the (subjective or frequentist) conditional probabilities chosen by the risk manager are internally consistent. The admissibility requirement greatly reduces the degree of arbitrariness in the conditional probability matrix if this is assigned subjectively. The approach can be used to address the requirements of the regulators on the Instantaneous Risk Charge.

Suggested Citation

  • Jan Kwiatkowski & Riccardo Rebonato, 2011. "A Coherent Aggregation Framework for Stress Testing and Scenario Analysis," Applied Mathematical Finance, Taylor & Francis Journals, vol. 18(2), pages 139-154.
    • Handle: RePEc:taf:apmtfi:v:18:y:2011:i:2:p:139-154
    DOI: 10.1080/1350486X.2010.491966
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    Cited by:

    1. Gloria Gonzalez-Rivera & Vladimir Rodriguez-Caballero & Esther Ruiz, 2023. "Expecting the unexpected: Stressed scenarios for economic growth," Working Papers 202314, University of California at Riverside, Department of Economics.
    2. Gloria González‐Rivera & C. Vladimir Rodríguez‐Caballero & Esther Ruiz, 2024. "Expecting the unexpected: Stressed scenarios for economic growth," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 39(5), pages 926-942, August.

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