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Developing a stress testing framework based on market risk models

journal contribution
posted on 2023-06-08, 12:23 authored by Carol AlexanderCarol Alexander, Elizabeth Sheedy
The Basel 2 Accord requires regulatory capital to cover stress tests, yet no coherent and objective framework for stress testing portfolios exists. We propose a new methodology for stress testing in the context of market risk models that can incorporate both volatility clustering and heavy tails. Empirical results compare the performance of eight risk models with four possible conditional and unconditional return distributions over different rolling estimation periods. When applied to major currency pairs using daily data spanning more than 20 years we find that stress test results should have little impact on current levels of foreign exchange regulatory capital.

History

Publication status

  • Published

Journal

Journal of Banking and Finance

ISSN

0378-4266

Publisher

Elsevier

Issue

10

Volume

32

Page range

2220-2236

Department affiliated with

  • Business and Management Publications

Full text available

  • No

Peer reviewed?

  • Yes

Legacy Posted Date

2012-09-11

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