Market risk stress testing Methodology

Abstract

Stress test has received increased attention from financial institutions, regulations and experts since
financial crisis 2008. In reality, Stress test has been actively adopted by international banks since the 1990s. ST
processes are varied among banks depending on economy background and supervisors but they are often
applied to test the performance of banks in the downturn of the economy through macro factors, assetsliabilities and off-balance sheet items. Stress test is designed not only to understand bank’s risk profile but
also to ensure that banks have adequate capital to reduce potential losses in adverse scenarios. Market risk
stress test is an important component of stress test including internal stresstest in banks and macro stress
test excuted by supervisors. During the 2008 financial crisis, the significant losses were often found in the
portfolio which were sensitive to market interest rates. Market risk stress test is applied for porfolios in the
trading book, using possible scenarios of market risk factors. This paper describes the basics of stress test and
Basel Commitees principles to design and governance stress test in banks. In additional, it emphasizes the
methodology of market risk tress test in banks