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VeryMeanReversion

Stress Testing

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Is it my imagination or didn't the BoE/FSA/Other require lenders to do a financial stress test of their balance sheets a couple of years ago to include of a 40% fall in house prices.

I wonder what the answers were.

Either way, the banks seemed to have failed the test.

Does anybody know anything about stress testing? Do they just say "nah mate, it'll never happen, Kirstie said so" then report back to the regulators.

VMR.

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Is it my imagination or didn't the BoE/FSA/Other require lenders to do a financial stress test of their balance sheets a couple of years ago to include of a 40% fall in house prices.

I wonder what the answers were.

Either way, the banks seemed to have failed the test.

Does anybody know anything about stress testing? Do they just say "nah mate, it'll never happen, Kirstie said so" then report back to the regulators.

VMR.

I don't know about the specifics of an FSA mandated house price correction stress test but do have the following general indictment of the risk management infrastructure at banks.

There are two basic tests that are run :

1. Value at Risk (VaR) is based on the nth percentile move over the last 1 to 3 years. The general problem with this approach is that it assumes that history will repeat itself and only reveals increased risk after periods of increased volatility. It is backward looking but the most standard tool used in bank risk management.

2. Stress testing is an additional set of tests run based on some "disaster scenarios" chosen at the banks' discretion. On a global basis, they are not uniform and are only as good as the scenarios chosen. I like them because they reveal gaps in portfolios. Many people (well until recently anyway) have tended to ignore stress testing as the scenarios are so far outside what they expect to see and the potential losses are so large that many thought that they were "nice" but meaningless. Closing out the most damaging scenarios tened to be so expensive that many businesses would have been much smaller had they been mmanaged to smaller numbers.

The problem that we have is that the most commonly used risk management tool is backward looking and doesn't allow for "black swan" events. Stress testing does reveal the outcome of "black swan" events but have traditionally been ignored by many as they render the underlying business unprofitable.

With the benefit of hindsight, we know what we should have done ....

Edited by LuckyOne

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There where no serious stress testing because they where all in la la land where everything is perfect, which means the mathematical models could run forever without failure.

Plus if they were stress tested properly it would have affected profit.

Edited by interestrateripoff

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There where no serious stress testing because they where all in la la land where everything is perfect, which means the mathematical models could run forever without failure.

Plus if they were stress tested properly it would have affected profit.

I think that you have described the vast majority of banks and businesses within those banks accurately.

I can also say that it is not a universal truth though. There are actually a few people out there who make sure that they have covered off as many "fat tails" as they can possibly contemplate even at the expense of their current revenue.

Disaster insurance is actually quite cheap when the disaster is nowhere to be seen ......

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  • 285 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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