Finding Stress Scenarios that Get the Job Done, with a Credit Risk Application

Abstract

We introduce new methods to generate finite representative collections of plausible yet severe scenarios. We apply these methods to generate single- obligor credit risk scenarios and demonstrate, via numerical experiments, that with respect to certain performance measures, our method is better able to discover (ex ante) scenarios “close” to those that occurred (as determined ex post), than previously described methods. Moreover, our methods discover these scenarios at substantially lower computational cost.

Keywords: Basel II, plausible yet severe scenarios, stress scenarios, copula models, loss scenarios, mean center methods