Journal of Risk

Risk.net

The quickest way to lose the money you cannot afford to lose: reverse stress testing with maximum entropy

Riccardo Rebonato

  • This paper presents the most likely combination of risk factors that can give rise to a pre-specified loss.
  • There are obvious applications to reverse stress testing.
  • The paper also shows how the method can be used in the context of scenario analysis.

We extend a technique devised by Saroka and Rebonato to “optimally” deform a yield curve in order to deal with a common and practically relevant class of optimization problems subject to linear constraints. In particular, we show how the idea can be applied to the case of reverse stress testing, and we present a case study to illustrate how it works. Finally, we point out a maximum-entropy interpretation of (or justification for) the procedure and present some obvious generalizations.

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an indvidual account here: