Stress Testing with Volatility-Weighted Historical Simulation: A Comparison of HS Methods

17 Pages Posted: 5 Jun 2008

See all articles by Sanjay Basu

Sanjay Basu

National Institute of Bank Management

Date Written: February 1, 2008

Abstract

The stress tests recommended by most central banks, for their supervisory review process, do not consider the probability of occurrence of the abnormal shocks. They also focus on worst-case scenarios and typically ignore the diversification benefits in a trading portfolio. However, stress tests based on simple historical simulation fail to affect VaR or the level of stress capital. Therefore, using data on USD-INR and GBP-INR between January 2000 and February 2001, we estimate the impact of stress scenarios on VaR and Expected Shortfall using volatility-weighted historical simulation. Our analysis takes care of fat tails and volatility clustering in a simple framework.

Keywords: Extreme Losses, Volatility updation, diversification, Fat tails, nonparametric methods

JEL Classification: G21, G32

Suggested Citation

Basu, Sanjay, Stress Testing with Volatility-Weighted Historical Simulation: A Comparison of HS Methods (February 1, 2008). Available at SSRN: https://ssrn.com/abstract=1140719 or http://dx.doi.org/10.2139/ssrn.1140719

Sanjay Basu (Contact Author)

National Institute of Bank Management ( email )

Kondhwe Khurd, NIBM P.O.
Pune, WY Maharashtra 411048
India

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