Case study on stress testing

Amazon default probabilities deteriorate as one would expect in the adverse and severe scenarios, but they quickly recover by the end of the stress test period:. American Express default probabilities show a high degree of resistance to the impact of deteriorating macro-economic conditions.


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They have a low sensitivity to the state of the economy. After the rescue of AIG by the U.

Stress testing within market and counter-party risk

Bank of New York Mellon also shows a surge in default risk in response to the severe scenario, but the adverse scenario has a relatively minor impact on default risk. Berkshire Hathaway shows almost no response to a change in economic scenarios. Default probabilities are quite low in all three scenarios.

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Goldman Sachs default probabilities rise to approximately one percent in the severe scenario, one of the strongest performances among major financial institutions. Huntington Bancshares default probabilities rise in a fashion more typical of major financial institutions. Oracle default probabilities do move in the adverse and severe scenarios, but in no case do they exceed one percent. Again, Oracle shows much less default risk cyclicality than major financial institutions.

Wal-mart is another firm whose default probabilities show only very modest sensitivity to the Fed scenarios, barely exceeding the 0. KRIS-CPM and Kamakura Risk Manager use the stress test scenarios to project the macro-economic factors in each period and derive the default probabilities that will prevail for all names in the portfolio a at each point in time and b in each Fed scenario.

In scenario k, say there are 10 defaulters. When we move to period 2 in scenario k, default probabilities will be generated for the survivors. If 15 more firms default, the surviving firms will be simulated, and so on. Cumulative losses would be proportionately smaller at a lower loss given default. For more on this approach, please contact us at Info KamakuraCo. Donald R. Register Login. Search My Blog Donald R. Trackback Print. Location: Blogs Donald R. Search My Blog. About Donald. Seeking Alpha. Twitter dvandeventer. Now Available. Contact Us.

June April November Following the financial crisis, regulatory reporting for the financial industry—specifically for banks—was significantly expanded with a broader focus on stress testing and capital adequacy, mainly due to the Dodd-Frank Act.

Case Study

These regulations require banks to report on their internal procedures for managing capital and carry out various stress-test scenarios. Much like the U. Stress testing involves running computer simulations to identify hidden vulnerabilities in institutions and investment portfolios to evaluate how well they might weather adverse events and market conditions.

Stress testing involves running simulations to identify hidden vulnerabilities. Among the most popular are stylized scenarios, hypotheticals, and historical scenarios. In a historical scenario, the business—or asset class, portfolio, or individual investment—is run through a simulation based on a previous crisis. A hypothetical stress test is generally more specific, often focusing on how a particular company might weather a particular crisis.

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Understanding the importance of stress degradation studies

For example, a firm in California might stress-test against a hypothetical earthquake or an oil company might do so against the outbreak of war in the Middle East. Stylized scenarios are a little more scientific in the sense that only one or a few test variables are adjusted at once.

As for the methodology for stress tests, Monte Carlo simulation is one of the most widely known. This type of stress testing can be used for modeling probabilities of various outcomes given specific variables. Factors considered in the Monte Carlo simulation, for example, often include various economic variables. Companies can also turn to professionally managed risk management and software providers for various types of stress tests.

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Stress Testing and Scenario Analysis

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