Journal of Credit Risk

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A framework for market, credit and transfer risk aggregation and stress testing

Simone Farinelli

  • A framework which consistently and fully integrates market, credit and country transfer risks of a general portfolio of financial assets in a multi-period setup is developed.
  • An appropriate definition of exposure, loss-given-defaults and loss-given-transfer-events provides a unified treatment of these three risk types. 
  • The framework discussed is generic and does not explicitly depend on the choice of the scenario generator.
  • Generic and macroeconomical stress tests is directly obtained by selecting the paths for which the relevant risk factors are constrained by a priori given bounds.

ABSTRACT

In this paper, a framework that consistently and fully integrates the market, credit and country transfer risks of a general portfolio of financial assets in a multi-period setup is developed. An appropriate definition of exposure, loss given default and loss given transfer events provides a unified treatment of these three risk types. Implementable algorithms are presented, as is a comparison with industry standards and best practices. The framework discussed is generic and does not explicitly depend on the choice of the scenario generator. Generic and macroeconomic stress tests are directly obtained by selecting the paths for which the relevant risk factors are constrained by a priori given bounds.

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