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Arrow_Blue_Orange.pngReverse Stress Testing Challenges: Toward a Systematic Framework


Regulators have strongly endorsed reverse stress testing programs within financial institutions since reverse stress tests can explicitly examine the solvency of a firm. Reverse stress tests are designed to identify economic scenarios that will threaten a firm's survival and potentially help managers hedge against hidden scenarios. These stress tests are attractive from a risk perspective, but implementing a reverse stress testing program that is independent of a manager’s bias is difficult.

In this paper, we outline a systematic, quantitative framework to design and construct reverse stress tests.

This paper is our third installment on stress testing.



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Arrow_Blue_Orange.pngReverse Stress Testing Challenges


Toward a Systematic Framework

Regulators have strongly endorsed reverse stress testing programs within financial institutions since reverse stress tests can explicitly examine the solvency of a firm. Reverse stress tests are designed to identify economic scenarios that will threaten a firm's survival and potentially help managers hedge against hidden scenarios. These stress tests are attractive from a risk perspective, but implementing a reverse stress testing program that is independent of a manager’s bias is difficult.

In this paper, we outline a systematic, quantitative framework to design and construct reverse stress tests.

This paper is our third installment on stress testing.



Authors:

  
Iulian Cotoi
Head of Quantitative
Pricing and Risk Analytics
Robert Stamicar
Strategic Innovation