Stress-Testing Credit Value-at-Risk: a Multiyear Approach

Alfred Hamerle, Rainer Jobst, Michael Knapp and Matthias Lerner

The relevance of forecasting future credit losses for loan portfolios under stressed scenarios is emphasised not only by current developments in the credit markets, such as the subprime crisis in the US and its impact on the global financial system. In Pillar II the new regulatory framework (Basel II) also demands sound stress-testing processes (see the Basel Committee on Banking Supervision 2004, paragraph 55 or the Committee of European Banking Supervision 2006).

A survey by the Committee on the Global Financial System (of the Bank for International Settlements) found that stress tests in loan books are done separately and infrequently compared to stress tests in trade books. The stressed scenarios focus on loan-related variables, such as the probability of default (PD) or recovery rate, and are often underpinned by a shock to macroeconomic variables (see the Committee on the Global Financial System 2005, p. 12). Here, mostly fixed, stressed scenarios are set in the literature available.11Compare to, eg, Pesaran et al (2005) or Hoeberichts et al (2006). For an overview of different stress tests of central banks, compare to Richter (2006). Simons and Rolwes (2008) show that such

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