The Quickest Way to Lose the Money You Cannot Afford to Lose: Reverse Stress Testing With Maximum Entropy

12 Pages Posted: 12 Feb 2018

Date Written: February 9, 2018

Abstract

We extend a technique devised by Saroka and Rebonato to “optimally” deform a yield curve in order to deal with a common and practically relevant class of optimization problems subject to linear constraints. In particular, we show how the idea can be applied to the case of reverse stress testing, and we present a case study to illustrate how it works. Finally, we point out a maximum-entropy interpretation of (or justification for) the procedure and present some obvious generalizations.

Keywords: reverse stress testing, maximum entropy, risk management, stress testing, yield curve deformation

Suggested Citation

Rebonato, Riccardo, The Quickest Way to Lose the Money You Cannot Afford to Lose: Reverse Stress Testing With Maximum Entropy (February 9, 2018). Journal of Risk, Vol. 20, No. 3, 2018. Available at SSRN: https://ssrn.com/abstract=3121285

Riccardo Rebonato (Contact Author)

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

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