Stress-testing financial systems: an overview of current methodologies

Working Papers No 165
December 2004
This paper reviews the state-of-the-art of macro stress-testing methodologies. Substantial progress has been made both in the econometric analysis of financial soundness indicators and in the simulation of value-at-risk measures to assess system-wide vulnerabilities. However, a number of methodological challenges still remain concerning the correlation of market and credit risks over time and across institutions, the limited time horizon generally used for the analysis and the potential instability of reduced-form parameter estimates because of feedback effects. Further research in this area might also focus on how to use macro stress-testing techniques as an operational tool to incorporate financial stability considerations into monetary policy decision-making.

JEL Classification Numbers: G21, G10, E37

Keywords: Macro stress-testing, financial soundness indicators, value at risk, feedback effects