Stress Testing with Market Data

Handbook of Stress Testing, Forthcoming

36 Pages Posted: 16 Sep 2020

See all articles by Robert F. Engle

Robert F. Engle

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); New York University (NYU) - Volatility and Risk Institute

Date Written: May 13, 2020

Abstract

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

Engle, Robert F., Stress Testing with Market Data (May 13, 2020). Handbook of Stress Testing, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3666145 or http://dx.doi.org/10.2139/ssrn.3666145

Robert F. Engle (Contact Author)

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Volatility and Risk Institute ( email )

44 West 4th Street
New York, NY 10012
United States

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