Rating Models and Validation - Oesterreichische Nationalbank

tify decisive factors influencing individual positions and to elucidate interrelationships
more effectively.
Multi-factor stress tests attempt to simulate reality more closely and examine
the effects of simultaneous changes in multiple risk factors. This type of stress
test is also referred to as a scenario stress test.
Scenarios can be designed either top-down or bottom-up. In the top-down
approach, a crisis event is assumed in order to identify its influence on risk factors.
The bottom-up approach involves direct changes in the risk factors without
assuming a specific crisis event.
However, what is more decisive in the development of a multi-factor stress
test is whether the risk factors and the accompanying assumed changes are
developed on the basis of past experience (historical crisis scenarios) or hypothetical
events (hypothetical crisis scenarios).
Historical crisis scenarios offer the advantage of enabling the use of historical
changes in risk factors, thus ensuring that all relevant risk factors are taken into
account and that the assumed changes are plausible on the basis of past experience.
In this context, the primary challenge is to select scenarios which are suited
to the credit portfolio and also applicable to the potential changes in general
conditions. Ultimately, no one crisis will ever be identical to another, which
means that extreme caution is required in the development of multi-factor
stress tests based on past experience.
Using hypothetical crisis situations is especially appropriate when the available
historical scenarios do not fit the characteristics of the credit portfolio, or when
it is desirable to examine the effects of new combinations of risk factors and
their changes.
In the construction of hypothetical crisis scenarios, it is especially important
to ensure that no relevant risk factors are omitted and that the simultaneous
changes in risk factors are sensible, comprehensible and plausible in economic
terms.
The main challenge in constructing these crisis scenarios is the fact that the
number of risk factors to be considered can be extremely high in a well-diversified
portfolio. Even if it is possible to include all relevant risk factors in the
crisis scenario, a subjective assessment of the interrelationships (correlations)
between the changes in individual risk factors is hardly possible.
For this reason, hypothetical crisis scenarios can also be developed systematically
with various mathematical tools and methods. 115
6.4.4 Performing and Evaluating Stress Tests
Once the crisis scenarios, the accompanying risk factors, and the size of the
changes in those factors have been defined, it is necessary to re-evaluate the
credit portfolio using these scenarios. If the bank uses quantitative models, it
can perform the stress tests by adjusting the relevant input factors (risk factors).
If no quantitative models exist, it is still possible to perform stress tests.
However, in such cases they will require greater effort because the effects on
the credit portfolio can only be estimated roughly in qualitative terms.
115 See MONETARY AUTHORITY OF SINGAPORE, Credit Stress-Testing, p. 42—44.
Rating Models and Validation
Guidelines on Credit Risk Management 137