Macro Stress Testing of Credit Risk Focused on the Tails

45 Pages Posted: 22 Aug 2010 Last revised: 7 Aug 2011

See all articles by Ricardo Schechtman

Ricardo Schechtman

Central Bank of Brazil - Research Department

Wagner Piazza Gaglianone

Central Bank of Brazil - Research Department

Date Written: April 19, 2011

Abstract

This paper investigates macro stress testing of system-wide credit risk with special focus on the tails of the credit risk distributions conditional on bad macroeconomic scenarios. These tails determine the ex-post solvency probabilities derived from the scenarios. This paper estimates the macro-credit risk link by both the traditional Wilson (1997) model as well as an alternative proposed quantile regression (QR) method (Koenker and Xiao, 2002), in which the relative importance of the macro variables can vary along the credit risk distribution, conceptually incorporating uncertainty in default correlations. Stress-testing exercises on the Brazilian household sector at the one-quarter horizon indicate that unemployment rate distress produces the most harmful effect, whereas distressed inflation and distressed interest rate show higher impacts at longer periods. Determining which of the two stress-testing approaches perceives the scenarios more severely depends on the type of comparison employed. The QR approach is concluded more conservative based on a proposed comparison of vertical distances between the tails of the conditional and unconditional credit risk cumulative distributions.

Keywords: macro stress test, credit risk, financial system, quantile regression

JEL Classification: C14, C15, E32, G28

Suggested Citation

Schechtman, Ricardo and Gaglianone, Wagner Piazza, Macro Stress Testing of Credit Risk Focused on the Tails (April 19, 2011). 24th Australasian Finance and Banking Conference 2011 Paper, Available at SSRN: https://ssrn.com/abstract=1662628 or http://dx.doi.org/10.2139/ssrn.1662628

Ricardo Schechtman (Contact Author)

Central Bank of Brazil - Research Department ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Wagner Piazza Gaglianone

Central Bank of Brazil - Research Department ( email )

SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70.000-000 DF 70074
Brazil

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