Developing a stress testing framework based on market risk models

By Carol Alexander, Elizabeth Sheedy. 2008

155 citations recorded by the source corpus.

The Basel 2 Accord requires regulatory capital to cover stress tests, yet no coherent and objective framework for stress testing portfolios exists. We propose a new methodology for stress testing in the context of market risk models that can incorporate both volatility clustering and heavy tails. Empirical results compare the performance of eight risk models with four possible conditional and unconditional return distributions over different rolling estimation periods. When applied to major currency pairs using daily data spanning more than 20 years we find that stress test results should have little impact on current levels of foreign exchange regulatory capital.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/94b385b702902e9981c6a2b4b3a902383ac75015

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Citations in the corpus

Copula-GARCH versus dynamic conditional correlation: an empirical study on VaR and ES forecasting accuracy (2013, methodology): “– The simulated log returns are then smoothed by kernel density estimation using the Epanechnikov kernel (Pritsker 2006; Alexander and Sheedy 2008), and the VaR at the 184 G.”
A framework for assessing the systemic risk of major financial institutions (2009, background): “Stress testing can be implemented to assess the market risk, as in Alexander and Sheedy (2008), or the credit risk, as in this paper. (2)In a recent related research, Hancock and Passmore (2008) propose a vector auto-regression in value-atrisk (VAR in VaR) approach, in which systemic and macroeconom”
The Level and Quality of Value-at-Risk Disclosure by Commercial Banks (2010, unknown): “5 Hirtle (2003) shows that US banks’ quarterly market risk charges contain valuable information about future risk exposures (see also Liu et al., 2004; Bali et al., 2007; Taylor, 2007; Alexander and Sheedy, 2008).”