Stress Testing Challenges:

Transcription

1 Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses JOSE CANALS-CERDA, Federal Reserve Bank of Philadelphia JUAN M. LICARI, Senior Director, Moody s Analytics OCTOBER 2015

2 Agenda 1. Data and model pitfalls when forecasting portfolio credit losses for stress test analysis 2. Transmission mechanisms: from scenario simulations to conditional risk parameter realizations 3. Producing consistent credit and market risk projections Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October 2015

3 2 Transmission Mechanisms: from scenario simulations to conditional risk parameter realizations Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October 2015

4 Density Cumulative Proportion Forward-Looking Scenario Generation & Severity Ranking GDP Growth, % Q/Q: Forecasts per Quarter Example of a Marginal Loading into Overall Scenario Rank-Ordering Algorithm +Q1 +Q2 +Q3 +Q4 +Q5 +Q6 +Q7 +Q8 +Q9 Density Function Max Cumulative Drop in GDP growth Scatter over Marginal Rank Order Max cumulative drop in GDP Growth Max Drop in Cumulative GDP Growth, % Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

5 Unemployment Rate, % Severity of Alternative Macroeconomic Scenarios Core Macro Series Across Scenario Blocks (Rank-Ordering Outcome) GDP Growth, % Q/Q: Over Scenario Blocks Unemployment Rate, %: Over Scenario Blocks Block 1 Block 2 Block 3 Block 4 Block 5 Block 1 Block 2 Block 3 Block 4 Block 5 Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

6 Severity of Alternative Macroeconomic Scenarios Scenario Probabilities GDP Growth, Q/Q % -- Alternative Severity Points Severity_0_50 Severity_0_90 Severity_0_95 Severity_0_99 Severity_0_999 Severity_0_ Prob of better outcome Scenario CCAR Baseline ECCA's s ECCA's Baseline ECCA's s ECCA's s CCAR Adverse ECCA's s ECCA's s CCAR Severely Adverse ECCA's s Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

7 Conditional Risk Parameter Realizations Impact on Government Bond Yields Yields, % Yields, % Yields, % Yields, % Government Bond Yields - Leading Maturities Simulations over Scenario Blocks (1 for Good, 5 for Stressed) at +Q9 3 Months 1 Year Block 1 Block 2 Block 3 Block 4 Block 5 Block 1 Block 2 Block 3 Block 4 Block 5 5 Years 10 Years Block 1 Block 2 Block 3 Block 4 Block 5 Block 1 Block 2 Block 3 Block 4 Block 5 Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

8 Yields, % Conditional Risk Parameter Realizations (cont.) Impact on Government Bond Yields (cont.) Government Bond Yield Curves Box-Plots Across Maturities at +Q9 3m 6m 1y 2y 3y 5y 7y 10y 20y 30y Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

9 Yield Curve Slope Yield Curve Slope Density Conditional Risk Parameter Realizations (cont.) Impact on Government Bond Yields (cont.) Yield Curve Slope (10y vs. 3m ) Analysis Over Quarters and Simulations Distribution for +Q9 Box-Plot for +Q Term Premium (10y vs. 3m ) Yield Curve Slope (10y vs. 3m ) +Q9 Values over Simulations Box-Plots, all +Qs Simulation id (1 for Good, for Stressed) +Q1 +Q2 +Q3 +Q4 +Q9 +Q6 +Q7 +Q8 +Q9 Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

10 Conditional Risk Parameter Realizations (cont.) Impact on Credit Spreads for Financials - over maturities and rating classes Aaa A 3m 1y 3y 5y 7y 10y 20y 30y 3m 1y 3y 5y 7y 10y 20y 30y Bbb Corporate Spread Curves - Financials 5 Quarters out of Sample (+Q5) - Across Rating Classes B 3m 1y 3y 5y 7y 10y 20y 30y 3m 1y 3y 5y 7y 10y 20y 30y Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

11 Conditional Risk Parameter Realizations (cont.) Impact on 5Y Credit Spreads for Financials - over quarters and rating classes Aaa A +Q1 +Q2 +Q3 +Q4 +Q5 +Q6 +Q7 +Q8 +Q9 +Q1 +Q2 +Q3 +Q4 +Q5 +Q6 +Q7 +Q8 +Q9 Bbb Corporate Spreads over Quarters-out-of-sample Financials - 5 Year Maturity - Across Rating Classes B +Q1 +Q2 +Q3 +Q4 +Q5 +Q6 +Q7 +Q8 +Q9 +Q1 +Q2 +Q3 +Q4 +Q5 +Q6 +Q7 +Q8 +Q9 Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

12 Concluding Remarks» Generating dynamic scenario simulations» Challenges in quantifying scenario probabilities» Leveraging stress testing models to produce consistent forward-looking market risk projections» Flexible framework to consolidate credit and market risk analysis (through stress testing equations) Stress Testing Challenges: Forecasting Consistent Credit & Market Risk Losses, October

13 Juan M. Licari, Ph.D. Senior Director +44 (0) tel +44 (0) mobile Moody's Analytics UK Ltd. moodys.com

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