Stress testing has become an important tool for risk management and a key part of the regulatory framework. This course discusses various approaches to generating stress scenarios, simple ‘what-if’ scenarios and simulation techniques through to the use of full structural macroeconomic models of the global economy. It will look at examples of impact on the balance sheet and P&L projections under stress scenarios.
Many types of risk can be exposed by stress testing that may not be apparent using only models calibrated to recent historical data. These risks are explored by looking at potential impact on regulatory indicators under stress scenarios. Hence the impact on capital ratios is explored and also the LCR and NSFR indicators of liquidity and the impact of stress scenarios on IRRBB (interest rate risk in the banking book) and the leverage ratio.
The course will also consider regulatory guidelines to stress testing and looks at regulatory stress testing exercises, for example, EBA/ECB, Bank of England and DFAST/CCAR.
An innovative area of focus on the course will be on coherent approaches to risk aggregation in order to construct an economic capital number based on stressed scenarios.
Participants will engage in Spreadsheet-based exercises and also role-playing exercises (live courses only) where time constraints and class sizes permit. Role-playing exercises will be used to practice engagement with a regulator, defending assumptions and responding to likely regulatory challenge.
The course has four main objectives:
- To provide a comprehensive overview of stress testing approaches
- Develop quantitative techniques:
- Scenario construction
- A look at some modelling techniques: Econometric models, vector autoregressions, Kalman Filters, stochastic simulation, pricing options, modelling behavioural options, non performing loans, basis risk, credit spreads.
- Mapping economic scenarios to risk factors affecting valuations and P&L
- Computation of risk metrics under stress: regulatory capital ratios, leverage ratio, EVE, NII, LCR and NSFR.
- Risk aggregation and assigning probabilities to stress scenarios in order to compute an economic capital number
