An Alternative Approach to Stress Testing a Bank’s Trading Book

Sean D Campbell, Amy Lorenc and Paweł J Szerszeń

A number of large bank holding companies (BHCs) are subject to a market risk stress test that subjects their trading book exposures to a market shock. This chapter proposes a simple and transparent trading book stress model that is motivated by standard risk management measurement approaches (ie, value-at-risk, VaR), and only requires data on a bank’s trading profit and loss (P&L) at the asset class level. The model makes use of variables that are already articulated in the macroeconomic stress scenario and does not require the articulation of a separate market shock. Finally, by design, the proposed stress model always produces losses and the relative size of the stress losses can be calibrated by adjusting one of several tuning parameters. Bank P&L data is used to estimate stress losses that would have resulted in the 2016 stress test had the proposed model been employed.

The stress-testing programme considers the mark-to-market losses borne by trading book assets for large US BHCs. The importance of trading and counterparty stress losses vary significantly across firms, and these losses account for over 50% of all stress losses at two banks and over 20% for three banks,

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