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Designing Scenarios in Macro Stress Testing at the Bank of Japan

October 26, 2015
Financial System and Bank Examination Department
Bank of Japan

Abstract

Macro stress testing is a tool for analyzing the effects of adverse shocks to economies and financial markets on the stability of the financial system by employing the model that incorporates the feedback loop between financial and macroeconomic sectors. In the test, stress scenario development processes (i.e., how to design a scenario that threatens financial system) are critical for assessing the stability of the financial system.

The Bank of Japan presents the results of the macro stress testing in the Financial System Report. While in previous issues different stress scenarios were employed for each issue, from the October 2015 issue, the tail event scenario and the tailored event scenario are employed. The tail event scenario is characterized by severely adverse financial and economic conditions equivalent to the Lehman shock each time and assesses the stability of the financial system through fixed-point observations. Even in the same scenario, the effect of the stress on the financial system would differ depending on the risk profile and capital strength of the financial institutions as well as financial and economic conditions. On the other hand, the tailored event scenario is flexibly designed to investigate the vulnerability of the financial system under different circumstances for every test and to assess transmission mechanisms of salient risks from a new point of view by extending the model and source data as appropriate.

This document explains the framework of scenario design as well as the narratives and rationale behind the developing of scenarios and provides in detail the scenario employed in the October 2015 issue of the Financial System Report.

To help financial institutions develop their own stress testing, the main variables in each scenario are available for downloading from the Bank of Japan's web site.

Notice

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Inquiries

Financial System Research Division, Financial System and Bank Examination Department

E-mail : post.bsd1@boj.or.jp