Stress Testing with Market Data
Handbook of Stress Testing, Forthcoming
36 Pages Posted: 16 Sep 2020
Date Written: May 13, 2020
A stress test assesses the value of a firm or asset in the future under an adverse counterfactual scenario. The critical points of stress tests are the valuation model and the scenario. This paper describes some of the difficulties in generating appropriate scenarios and valuing firms under these scenarios. In most cases, these difficulties can be solved if the regulator is better informed than the market. However, if this is not correct at all times and settings, then it is also sensible to carry out stress tests with market scenarios and market data. When these stress tests agree, the results gain added credibility. When they disagree, the parties can discuss whether the market has missed signals, or whether the regulators’ models are wrong or have been politically impacted.
Detailed analysis of SRISK, a market based stress test, is presented from an economic, econometric and historical point of view. This is compared with alternative measures such as SES and CoVaR and with regulatory stress tests.
Keywords: Stress Test, DCB, SRISK, VLAB, COVAR, SES,DCC, Regulation, Banking
JEL Classification: G01,G18,G21,G28
Suggested Citation: Suggested Citation