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A theory of multivariate stress testing

Millossovich, P. ORCID: 0000-0001-8269-7507, Tsanakas, A. ORCID: 0000-0003-4552-5532 and Wang, R. (2021). A theory of multivariate stress testing. .

Abstract

We present a theoretical framework for stressing multivariate stochastic models. We consider a stress to be a change of measure, placing a higher weight on multivariate scenarios of interest. In particular, a stressing mechanism is a mapping from random vectors to RadonNikodym densities. We postulate desirable properties for stressing mechanisms addressing alternative objectives. Consistently with our focus on dependence, we require throughout invariance to monotonic transformations of risk factors. We study in detail the properties of two families of stressing mechanisms, based respectively on mixtures of univariate stresses and on transformations of statistics we call Spearman and Kendall’s cores. Furthermore, we characterize the aggregation properties of those stressing mechanisms, which motivate their use in deriving new capital allocation methods, with properties different to those typically found in the literature. The proposed methods are applied to stress testing and capital allocation, using the simulation model of a UK-based non-life insurer.

Publication Type: Monograph (Working Paper)
Additional Information: Copyright, 2021, the authors.
Publisher Keywords: Stress testing, dependence, change of measure, risk measure, probability distortion, systemic risk
Subjects: H Social Sciences > HG Finance
Departments: Bayes Business School > Actuarial Science & Insurance
Date available in CRO: 22 Nov 2021 09:47
Date of first online publication: 18 November 2021
URI: https://openaccess.city.ac.uk/id/eprint/27114
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