Reverse Stress testing from a Macroeconomic Viewpoint

Original by Moody’s analytics, 2012, 14 pages 

This summary note was Posted on

  • Paper has a mathematical approach to RST
  • FSA definition: “Test that require a firm to assess scenarios and circumstances that would render its business model unviable, thereby potential vulnerabilities. Reverse stress-testing starts from an outcome of business failure and identifies circumstances where this might occur. This is different to general stress and scenario testing which tests for outcomes arising from changes in circumstances”
  • Use top ~20 macro economics series
  • Apply factor analysis to keep relevant series
  • Reverse stress testing suffer from multiplicity (several solution to an end result)
  • Type I multiplicity: Indeterminacy (more variables than equations) -> Use factor analysis
  • Type II multiplicity: Properties on an inverse mapping, the reverse of a function might not behave as a function ->use of linear algebra to handle the inverse mapping of linear equations