Developing a stress testing framework based on …

Developing a stress testing framework based on market risk modelsqCarol Alexander, Elizabeth Sheedy*ICMA Centre, University of Reading, Box 242, Reading RG6 6BA, UKMacquarie Applied Finance Centre, Macquarie University, Sydney, AustraliaReceived 29 May 2007; accepted 31 December 2007 Available online 15 January 2008 AbstractThe Basel 2 Accord requires regulatory capital to cover stress tests, yet no coherent and objective framework for stress testing port-folios exists. We propose a new methodology for stress testing in the context of market risk models that can incorporate both volatilityclustering and heavy tails. Empirical results compare the performance of eight risk models with four possible conditional and uncondi-tional return distributions over different rolling estimation periods.

Developing a stress testing framework based on market risk modelsq Carol Alexander, Elizabeth Sheedy* ICMA Centre, University of Reading, P.O. Box 242, Reading RG6 6BA, UK

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