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Implications of a Macro Stress Test on Financial Stability: Summary of the second census on stress tests

December 6, 2002
Makoto Hosoya
Tokiko Shimizu

The views expressed in the Review are those of the authors and do not necessarily represent the views of the Bank of Japan. Comments and questions as well as requests for hard copies should be addressed to Tokiko Shimizu, Manager, Financial Markets Department (tokiko.shimizu@boj.or.jp).

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The Financial Markets Department conducted its second census of stress tests to collect and analyse stress scenarios adopted by market participants. In a sense, the exercise was conceived as a market-wide "fire drill" assuming situations where serious shocks occur in financial markets. Through the census, it became evident that the following three points need to be duly taken into account in order to understand the mechanism through which stress develops: (1) the combined effects arising from changes in multiple risk factors, (2) the speed with which stress materialises and spreads through the market, and (3) the change in the resiliency of markets to stress caused by changes in economic and financial conditions and in market structure. In particular, when the effects of stress events evolve into a vicious circle involving the real economy, financial markets, and the banking sector, policy measures will become necessary to stem the movement. The aim of the exercise is to reinforce market resiliency to stress by sharing the results of the census with market participants, thereby facilitating the understanding of the mechanisms through which stress materialises and develops.