A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing

By Christian Schmieder, Tidiane Kinda, Nassim N. Taleb, Elena Loukoianova, Elie Canetti

August 1, 2012

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Format: Chicago

Christian Schmieder, Tidiane Kinda, Nassim N. Taleb, Elena Loukoianova, and Elie Canetti. A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing, (USA: International Monetary Fund, 2012) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.

Subject: Banking, Credit, Financial sector policy and analysis, Money, National accounts, Personal income, Public debt, Solvency stress testing, Stress testing

Keywords: Bank, Bank capitalization, Basic procedure, Contagion risk stress tests, Credit, Debt, Forecasting, Global, Inappropriate method, Interconnectivity risk, Personal income, Procedure, Solvency stress testing, Stability, Standardized method, Stress Testing, Tail risk, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2012/216
Stock No:

WPIEA2012216
ISBN:

9781475505665
ISSN:

1018-5941

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