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A financially justifiable and practically implementable approach to coherent stress testing

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  • Riccardo Rebonato

Abstract

We present an approach to stress testing that is both practically implementable and solidly rooted in well-established financial theory. We present our results in a Bayesian-net context, but the approach can be extended to different settings. We show (i) how the consistency and continuity conditions are satisfied; (ii) how the result of a scenario can be consistently cascaded from a small number of macrofinancial variables to the constituents of a granular portfolio; and (iii) how an approximate but robust estimate of the likelihood of a given scenario can be estimated. This is particularly important for regulatory and capital-adequacy applications.

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  • Riccardo Rebonato, 2019. "A financially justifiable and practically implementable approach to coherent stress testing," Quantitative Finance, Taylor & Francis Journals, vol. 19(5), pages 827-842, May.
    • Handle: RePEc:taf:quantf:v:19:y:2019:i:5:p:827-842
    DOI: 10.1080/14697688.2018.1532103
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    Cited by:

    1. Gonzalez Rivera, Gloria & Rodríguez Caballero, Carlos Vladimir, 2021. "Expecting the unexpected: economic growth under stress," DES - Working Papers. Statistics and Econometrics. WS 32148, Universidad Carlos III de Madrid. Departamento de Estadística.

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