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last update : 18/01/2016

Stress And Scenario Testing

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COURSE OBJECTIVE

 

Stress testing is a critical and continually-developing topic within risk management. Risk measurement and management would be woefully inadequate (if not impossible) without stress testing. Stress testing is specifically required by the Basel II Accord, and is thus a constituent of regulatory scrutiny. Despite the importance of stress testing, it is still a de-veloping subject characterised by a lack of understanding and knowledge of acceptable ap-proaches. 

This course addresses current thinking on stress testing and scenario selection and genera-tion (the lesser known, but no less important) accessory of stress testing) and considers its application to market, credit, operational and liquidity risk.

 

About

At the end of the course participants will be able to: 

 

  • Understand the relevance of stress testing and scenario generation within the context of risk management in general
  • Appreciate the subtleties of stress and scenario testing 
  • Implement the latest stress testing methodologies for implementing stress and scenario tests
  • Assess the relevance of stress tests applied to specific situations via case studies
  • Understand the reasons for the meltdown caused by (mainly CDOs and other struc-tured finance products) in mid 2007 due to inadequate stress testing
  • Appreciate the role the Monte Carlo technique (for generating simulated variables) plays in stress testing and scenario generation for market risk
  • Appreciate the role the single factor model (for generating correlated losses) plays in stress testing and scenario generation of credit risk
  • Know the details of how and when to use Monte Carlo (simulated) data and when to use purely historical data
  • Know the effect of stress testing on banks’ capital.

 

Agenda

 

DAY ONE :

Session 1: 

Stress testing and pricing financial instruments

 

  • What is stress testing and when does an institution suffer stress?
  • How do pricing models work – what are the basics of what goes into pricing models?
  • What is scenario modelling?
  • What are the benefits of stress testing? Some case studies
  • What problems can be attributed to stress testing?
  • How much can you stress and still produce reliable results?

 

Case Study/Exercise: Exploring some pricing models and their sensitivity to the inputs which comprise their structure.

 

Session 2:

Stress testing and market risk

 

  • How do risk models work – what are the basics of what goes into risk measurement models?
  • Stress testing and market risk
  • The regulatory requirements for market risk
  • What are the regulatory requirements related to stress testing for market risk?
  • Macro stress testing of banks – Basel’s approach
  • Survey of current practice – Basel’s paper
  • An introduction to Monte Carlo

 

Case Study/Exercise: The rudiments of the Monte Carlo simulation technique. Construction in Excel of a basic Monte Carlo calculator and apply it to a market portfolio to assess VaR using MC.

 

DAY TWO :

Session 3:

Stress testing and credit risk

 

  • Stress testing and credit risk
  • The regulatory requirements for credit risk
  • What are the regulatory requirements related to stress testing for credit risk?
  • Macro stress testing of banks – Basel’s approach
  • Survey of current practice – Basel’s paper
  • An introduction to the single factor model – how does this relate to scenario gen-eration and, eventually, stress testing?

 

Case Study/Exercise: The rudiments of the single factor model so prevalent in credit risk models. Construction in Excel of a basic single factor model and application of this model to a basic portfolio of credits (to model credit losses as well as (eg) a simple CDO). 

 

Session 4:

Stress testing and operational and liquidity risk + effects on capital

 

  • Stress testing and operational risk
  • The regulatory requirements for operational risk
  • What are the regulatory requirements related to stress testing for operational risk? How do these differ from the other risk categories?
  • Macro stress testing of banks – Basel’s approach
  • Survey of current practice – Basel’s paper
  • Stress testing for liquidity risk including data quality issues and actions that might result
  • Can stress tests be combined?
  • Extreme stress testing
  • Stress testing and capital

 

Case Study/Exercise: The effect on capital and Pillar 2 of the Basel II accord. A simple ex-ample executed in Excel to demonstrate the effect on bank regulatory and economic capital. 

 

Instructor Bio

He is currently Senior Director in the Financial Institutions Special Projects Group of Fitch Ratings, London. As a quantitative analyst he holds responsibility for overseeing all quantitative aspects of projects which require mathematical or statistical input. He is also responsible for managing the implementation, testing and validation aspects of Basel II and risk management in global financial institutions for Fitch. Gary is an energetic and highly motivated financial services specialist with a passion for sharing knowledge and teaching.

He was head of the Quantitative Analysis Group at Ernst & Young in London before he moved to Fitch as Senior Director in early 2006. 

He began his career in nuclear physics at South Africa's Atomic Energy Corporation before moving on to market risk management at ABSA Bank, Johannesburg, then Old Mutual Asset Managers in Cape Town and Standard Bank in London. 

His qualifications include two PhDs, the first in Nuclear Physics from the University of Natal and the second in Credit Risk Management from the University of the Northwest (both in South Africa). Gary is also a qualified GARP-accredited Financial Risk Manager who conducts Risk Reward financial modeling, financial mathematics and risk training assignments in London and internationally

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