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A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing
Author:
Mr. Christian Schmieder
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Mr. Tidiane Kinda
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Mr. Nassim N. Taleb null

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Ms. Elena Loukoianova
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Mr. Elie Canetti
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Series:
IMF Working Papers
Volume/Issue:
Volume 2012: Issue 216
Language:
English
Publication Date:
01 Aug 2012
DOI:
https://doi.org/10.5089/9781475505665.001
ISBN:
9781475505665
ISSN:
1018-5941
Pages:
24
Keywords:
WP; procedure; debt; bank; bank capitalization; Stress Testing; Forecasting; Stability; tail risk; contagion risk stress tests; inappropriate method; interconnectivity risk; standardized method; basic procedure; Personal income; Credit; Solvency stress testing; Global
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund