A Comprehensive Framework for Quantitative Stress Tests in Financial Institutions

26 Pages Posted: 20 Jun 2013

See all articles by Yasushi Takano

Yasushi Takano

Mizuho-DL Financial Technology Co., Ltd.

Jiro Hashiba

Mizuho-DL Financial Technology Co., Ltd.

Rintaro Anraku

Mizuho-DL Financial Technology Co., Ltd.

Ryuichi Sato

Mizuho-DL Financial Technology Co., Ltd.

Sakae Mizuki

Mizuho-DL Financial Technology Co., Ltd.

Akinori Kohno

Mizuho-DL Financial Technology Co., Ltd.

Date Written: June 19, 2013

Abstract

In recent years, the importance of stress tests as a complement to VaR framework is widely recognized by both financial regulators and risk management practitioners.To perform credit risk stress tests in a financial institution, one must quantify the impact of macroeconomic shocks on a credit portfolio.To this end, we enhance the widely used firm-value model by incorporating macroeconomic factors and apply a fast computation technique of moment generating function (MGF) to the enhanced model. Since various risk measures and risk contributions can be obtained by the Laplace inversion of MGF and its derivatives, risk management practitioners can analyze the risk characteristics of their credit portfolio in detail under given macroeconomic conditions. In addition, based on our framework, one can also perform quantitative reverse stress tests. More specifically, one can calculate the conditional distribution of macroeconomic factors under the condition that severe losses have occurred in a credit portfolio. Thus, risk managers can investigate under what macroeconomic conditions their financial institution has difficulty in its management. In this way, our methodology provides a comprehensive stress test framework that can be used for practical risk management.

Keywords: stress test, reverse stress test, action plan, multi-factor firm-value model, Laplace inversion

JEL Classification: G21, G32, C63

Suggested Citation

Takano, Yasushi and Hashiba, Jiro and Anraku, Rintaro and Sato, Ryuichi and Mizuki, Sakae and Kohno, Akinori, A Comprehensive Framework for Quantitative Stress Tests in Financial Institutions (June 19, 2013). Available at SSRN: https://ssrn.com/abstract=2281765 or http://dx.doi.org/10.2139/ssrn.2281765

Yasushi Takano

Mizuho-DL Financial Technology Co., Ltd. ( email )

Japan

Jiro Hashiba (Contact Author)

Mizuho-DL Financial Technology Co., Ltd. ( email )

Japan

Rintaro Anraku

Mizuho-DL Financial Technology Co., Ltd. ( email )

Japan

Ryuichi Sato

Mizuho-DL Financial Technology Co., Ltd. ( email )

Japan

Sakae Mizuki

Mizuho-DL Financial Technology Co., Ltd. ( email )

Japan

Akinori Kohno

Mizuho-DL Financial Technology Co., Ltd. ( email )

Japan

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