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Stress testing / Liquidity and funding risk [14]

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Bullet points include: Some authors argue for integration of risk modelling and stress testing, e.g. Berkowitz (1999) By adopting a ‘meta’ probability distribution characterising plausibility of scenarios, we can in principle objectively select stress test scenarios And by, say, using the concept of ‘relative entropy’ we can even identify which scenario (with a given level of implausibility) generates the worst outcome for our portfolio (out of all possible scenarios), see e.g. Breuer (2009) But these sorts of approaches sit uncomfortably with the lesser focus on likelihood that is typically implicit in stress testing And may not be very helpful in identifying appropriate mitigating actions

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