Stress Testing

EEIO in Sustainable Finance

EEIO in Sustainable Finance

EEIO in Sustainable Finance - Challenges and Opportunities. This is a Presentation given given at the 15th I-O Workshop, March 1st 2024, Osnabruck, Germany.

Reading Time: 1 min.

EEIO in Sustainable Finance: Challenges and Opportunities

Presentation given at the 15th I-O Workshop, March 1st 2024, Osnabrueck, Germany

We discuss the overlap of EEIO tools with Sustainable Finance applications. In particular their potential role in Portfolio Management and, more specifically,

  • the Attribution of environmental impact in financial portfolios and,
  • the Allocation of future financial resources and sustainability constraints

We sketch two proof-of-concept computer applications that highlight opportunities and challenges:

First public release of the Solstice simulation framework

First public release of the Solstice simulation framework

Solstice is a flexible open source economic network simulator. Its primary outcomes are quantitative analyses of the behavior of economic systems under uncertainty. In this post we provide a first overall description of Solstice to accompany the first public release.

Reading Time: 5 min.

Modeling economic networks and their dynamics

Economic networks are the primary abstractions though which we can conceptualize the state (condition) and evolution of economic interactions. This simply reflects the fact that human economies are quite fundamentally systems of interacting actors (or nodes in a network) with transient or more permanent relations between them.

In practice the network character of an economy is frequently suppressed or under-emphasized and does not play a particularly important role. This may be for reasons of expediency (inadequacy of data characterising the network in detail) or because the objectives of the analysis can be obtained without detailed micro-data that capture network properties (e.g., it may be sufficient to work with sectoral aggregates or “representative” agents).

Stress Testing of the Future - A view from 2031

Stress Testing of the Future - A view from 2031

What is the future of stress testing? We speculate on how stress testing might look like in 2031

Reading Time: 13 min.

EBA 2031

What is the future of stress testing?

To speculate on the future of Stress Testing we need first a basic definition what stress testing is. Broadly speaking, the goal of Stress Testing is to assess how a system would behave under adverse conditions that - while not the most likely outcome with the knowledge of today - are within the realm of the plausible.

There are, broadly speaking, two types of stress testing: The Real stress testing version and Hypothetical stress testing version. Let us start with examining the “real stuff” first.

Machine learning approaches to synthetic credit data

Machine learning approaches to synthetic credit data

Reading Time: 9 min.

The challenge with historical credit data

Historical credit data are vital for a host of credit portfolio management activities: Starting with assessment of the performance of different types of credits and all the way to the construction of sophisticated credit risk models. Such is the importance of data inputs that for risk models impacting significant decision-making / external reporting there are even prescribed minimum requirements for the type and quality of necessary historical credit data.

Stressing Transition Matrices

Stressing Transition Matrices

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Release of version 0.4.1 of the transitionMatrix package focuses on stressing transition matrices

Stressed Density

Further building the open source OpenCPM toolkit this realease of transitionMatrix features:

  1. Feature: Added functionality for conditioning multi-period transition matrices
  2. Training: Example calculation and visualization of conditional matrices
  3. Datasets: State space description and CGS mappings for top-6 credit rating agencies

Conditional Transition Probabilities

The calculation of conditional transition probabilities given an empirical transition matrix is a highly non-trivial task involving many modelling assumptions. This version of the transitionMatrix includes a canonical implementation that assumes a Gaussian single factor process as the driver of the joint rating dynamics. The technical documentation is available under in Open Risk Manual under the transition matrix category.

Release 0.4 of transitionMatrix adds Aalen-Johansen estimators

Release 0.4 of transitionMatrix adds Aalen-Johansen estimators

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Release of version 0.4 of the transitionMatrix package

Release 0.4

Further building the open source OpenCPM toolkit this realease of transitionMatrix features:

  1. Feature: Added Aalen-Johansen Duration Estimator
  2. Documentation: Major overhaul of documentation, now targeting ReadTheDocs distribution
  3. Training: Streamlining of all examples
  4. Installation: Pypi and wheel installation options
  5. Datasets: Synthetic Datasets in long format

Enjoy!

Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era

Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era

Reading Time: 3 min.

Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era

The post-crisis world presents portfolio managers with the significant challenge to asimilate in day-to-day management the variety of conceptual frameworks now simultaneously applicable in the assessment of portfolio credit risk:

  • The first major strand is the widespread application of regulatory stress testing methodologies in the estimation of regulatory risk capital requirements
  • The second major strand is the introduction of new accounting standards (IFRS 9 / CECL) for the measurement and disclosure of expected credit losses While both Regulatory Stress Testing and IFRS 9 / CECL accounting require investment in analytic capabilities and provide unique new insights, both are aimed at satisfying evolving prudential or investor disclosure requirements. Neither is designed to help credit portfolio managers analyse and steer their portfolios in the bottom-up fashion that is an essential part their mandate.

The above developments are overlaid into pre-existing conceptual and practical frameworks such as

IFRS 9 Expected Credit Loss and Risk Capital

IFRS 9 Expected Credit Loss and Risk Capital

Reading Time: 5 min.

The new IFRS 9 financial reporting standard

IFRS 9 (and the closely related CECL) is a brand new financial reporting standard developed and approved by the International Accounting Standards Board (IASB).

Strictly speaking IFRS 9 concerns only the accounting and reporting of financial instruments (e.g. bank loans and similar credit products). Yet the introduction of the IFRS 9 standard has significant repercussions beyond financial reporting, and touches e.g., bank risk management as well. This is prompted by the fact that the framework requires embedding forward looking risk assessments in the measurement of the value of credit assets currently on the balance sheet.

How to Stress Test Financial Weapons of Mass Destruction

How to Stress Test Financial Weapons of Mass Destruction

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How to Stress Test Financial Weapons of Mass Destruction

In recent decades we have been collectively spared the haunting images and existential anxiety provoked by the sight of detonating nuclear weapons for testing purposes - not to mention the increased levels of radiation in the atmosphere and other side-effects. This achievement is largely thanks to a series of treaties to control nuclear bomb testing that have been signed and enforced by most (unhappily not all) countries worldwide.

FX Lending Risk

FX Lending Risk

Reading Time: 3 min.

FX Lending Risk

FX Volatility

A stress testing methodology for analyzing FX lending risk. Extends standard credit risk modelling tools to capture the increased risks of FX lending in a consistent way


Financial Weapons of Mass Destruction

Warren Buffet famously declared financial derivatives as weapons of mass destruction (although apparently this did not prohibit him from using them when convenient). The leverage afforded by such contracts, their potential complexity, or simply their novelty which may imply lack of understanding, are some reasons why one would classify them as potential contributors of systemic risk, which is a polished rephrasing of the more popular this sucker is going down quote.

06, Stress Testing Methodology for FX Lending

06, Stress Testing Methodology for FX Lending

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Open Risk White Paper 6: Stress Testing Methodology for FX Lending

FX Volatility

We develop a simple methodology for stress testing portfolios of credit instruments classified as foreign exchange lending. Loans whose repayment schedule is denominated in a currency other than that of the borrower’s domestic currency are commonly seen in many jurisdictions and have a risk profile that is considerably more complicated than domestic currency loans. Yet the literature for credit risk assessment and stress testing of portfolios of such loans is very limited, which means that Stress Testing and Internal Capital Adequacy Assessment (ICAAP) requirements are harder to meet. Our methodology builds on existing standard tools used in portfolio credit risk modeling and enables obtaining insights into the additional risk factors embedded in foreign currency lending.

The mystery of the collapsed cathedral

The mystery of the collapsed cathedral

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The mystery of the collapsed cathedral

Remains of the Cathedral

You walk to the center of an old city, and you see its glorious cathedral lying in ruins. What in the world has happened here? Your investigative instinct goes into overdrive. This is not supposed to happen. Not in peacetime anyway. How can it be that this magnificent edifice, after gracing the town’s central square for who knows how many centuries, is now little more than a rubble pile in the center of town?

The periodic table of risk elements

The periodic table of risk elements

Reading Time: 5 min.

The periodic table of risk elements

The_Periodic_Table_of_Risk_Elements

You know the periodic table of elements, even if you flunked your science courses! It is the large colorful and blocky table that hanged on every school’s classrooms before becoming yet another mobile app. The periodic table is one of the early and iconic achievements of science. It lists all the pure chemical elements found in nature, the building blocks of all possible material substances. Each block contains a set of numbers that unambiguously characterizes each element and a single or two letter abbreviation for each: H for Hydrogen, He for Helium and so forth, going on for over a hundred different elements. When the periodic table was discovered by Mendeleev (apparently in his dream!) it was an extraordinary realization that the physical world has an underlying order at the microscopic level. In his own words:

Visualizing the Stress of US Banks

Visualizing the Stress of US Banks

Reading Time: 4 min.

Visualizing the Stress of US Banks

A recurring cycle of regulatory stress testing exercises has become the new normal in the banking world, at least on the two shores of the northern Atlantic. The periodicity of the European stress testing heartbeat has not yet been firmly established. Did we just miss a beat in 2015 (a so called palpitation) or will the European cycle have two (or more) years periodicity? Who knows. Fortunately, there are no such uncertainties around the US stress testing cycle. The US CCAR rhythm seems to be a very robust annual throb and in March we just got the latest iteration.