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Working Paper
Robust stress testing
In recent years, stress testing has become an important component of financial and macro-prudential regulation. Despite the general consensus that such testing has been useful in many dimensions, the techniques of stress testing are still being honed and debated. This paper contributes to this debate in proposing the use of robust forecasting analysis to identify and construct adverse scenarios that are naturally interpretable as stress tests. These scenarios emerge from a particular pessimistic twist to a benchmark forecasting model, referred to as a ?worst case distribution?. This offers ...
Journal Article
Dynamic provisioning: a countercyclical tool for loan loss reserves
In the wake of the financial crisis of 2007-2009, as various banking policymakers revisit loan loss provisioning rules, the Spanish approach of dynamic provisioning has garnered attention as a potential alternative to the current incurred loss approach. We review the current approach to loan loss reserves in the United States, focusing on how loan loss reserves relate to bank solvency and why the current accounting approach may have procyclical effects. We present a conceptual framework to compare loan loss provisioning under the incurred loss framework and dynamic provisioning. Then we ...
Working Paper
Stress Testing with Misspecified Models
Stress testing has become an important component of macroprudential regulation yet its goals and implementation are still being debated, reflecting the difficulty of designing such frameworks in the context of enormous model uncertainty. We illustrate methods for responding to possible misspecifications in models used for assessing bank vulnerabilities. We show how ?exponential tilting? allows the incorporation of external judgment, captured in moment conditions, into a forecasting model as a partial correction for misspecification. We also make use of methods from robust control to seek the ...