Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/154278
Authors: 
Gross, Marco
Población, Javier
Year of Publication: 
2015
Series/Report no.: 
ECB Working Paper 1845
Abstract: 
The purpose of this paper is to promote the use of Bayesian model averaging for the design of satellite models that financial institutions employ for stress testing. Banks employing ’handpicked’ equations – while meeting standard economic and econometric soundness criteria – risk significantly underestimating the response of risk parameters and therefore overestimating their capital absorption capacity. We present a set of credit risk models for 18 EU countries based both on the model averaging scheme as well as a series of handpicked equations and apply them to a sample of 108 SSM banks. We thereby aim to illustrate that the handpicked equations may indeed imply significantly lower default flow estimates and therefore overoptimistic estimates for the banks’ capital absorption capacity. The model averaging scheme that we promote should mitigate that risk and also help establish a level playing field with regard to a common level of conservatism across banks.
Subjects: 
bank regulation and supervision
model averaging
satellite modeling
stress testing
JEL: 
C11
C22
C51
E58
G21
ISBN: 
978-92-899-1658-5
Document Type: 
Working Paper

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