Stress-Testing Models: A Strategic Risk Management Tool

14 Pages Posted: 27 Nov 2017

Date Written: July 24, 2013

Abstract

This paper discusses the role of models in conducting stress-tests for regulatory and risk management purposes, and presents some approaches that may enhance their ability to estimate outcomes in a stressful environment. Unlike a conventional model that is designed for a steady state environment, we argue that a stress-testing model needs to be developed with a different design to capture the implications of abnormal business and economic conditions. Developing such a model may require a combination of qualitative and quantitative adjustments to capture the stress or boundary conditions. Consequently, the governance needs of stress- testing models require more rigor than steady state models to effectively challenge the underlying construct and assumptions. It is critical that senior management appreciate these nuances before using the output of such models for key strategic decisions.

Suggested Citation

Sangha, Balvinder and Lin, Jane, Stress-Testing Models: A Strategic Risk Management Tool (July 24, 2013). Journal of Financial Perspectives, Vol. 1, No. 2, 2013, Available at SSRN: https://ssrn.com/abstract=3076906

Balvinder Sangha (Contact Author)

Ernst & Young LLP ( email )

One MOre London Place
1225 Connecticut Ave NW # 700
New York, NY SE1 2AF
United States

Jane Lin

Ernst & Young LLP

One MOre London Place
1225 Connecticut Ave NW # 700
New York, NY SE1 2AF
United States

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