Scenario Analysis & Stress Testing...Apr 04, 2011 · Scenario Analysis for RiskAnalyst and RiskOrigins 6 There are issues with the current practices •Most solutions lack, in one

Scenario Analysis & Stress Testing

April 2011

Theodoros Theodorou

2Scenario Analysis for RiskAnalyst and RiskOrigins

Disclaimer

Information regarding products, features,

specifications and functionality in

Moody’s Analytics products is intended

to outline Moody’s Analytics general

product direction but is not guaranteed.

Future products will be sold only when

and if available. Moody’s Analytics

reserves our right to change the

development, release, and timing of

features and functionality at anytime.

2


Agenda

1. Key subject today: a new tool to do scenario analysis – to address the following

challenges:

• Produce frequently reports on portfolio movement based on PD/LGD adjustments

• Stress test the models – necessary for model validation, perhaps a future demand from

regulators

2.What is Scenario Analysis? The vision going forward

3.Details on the product about to be released – benefits for RiskAnalyst & RiskOrigins

clients

4.Questions


Historically, a shared topic and concern – now in the forefront

•Scenario Analysis was already part of most risk management areas

before the last crisis:

– Historical scenario analysis for market risk

– Economic Capital stress testing

– Regulatory Capital stress testing

– Asset&Liability management scenarios

• The credit crisis put the spotlight on models and stress testing:

– Senior management requires more frequent and informed results

– Regulatory requirements becoming more demanding and extensive


“Scenario Analysis” – no unique definition, different challenges:

Depending on the area, “Scenario Analysis” can refer to different ideas.

•Current focus is on high level stress testing:

» Create Macroeconomic scenarios

» Forecast PD and LGD for different sectors arrive at loss estimates

under given scenarios.

» Challenge: how to link Economic stress scenarios to PD/LGD by sector

that can provide meaningful stress results

•An area that has started to be investigated is testing of models

» Forecast of sales/profits/leverage may be easier – key drivers to models

» Question: How will models behave under these changed parameters?

•The vision is a holistic approach to cover all areas

» Key challenge: lack of integrated models


There are issues with the current practices

•Most solutions lack, in one way or the other, in terms of:

– Integration (integration across silos, integration with data and contents etc)

– Usability, best practices

– Expertise (models, engines, interpretation of macroeconomic drivers)

•This was highlighted by various onlookers, including BIS in 2009:

“The financial crisis has highlighted weaknesses in stress testing practices employed prior to

the start of the crisis in four broad areas:

(i) use of stress testing and integration in risk governance

(ii) stress testing methodologies

(iii) scenario selection

(iv) stress testing of specific risks and products” *

* Principles for Sound Stress Testing Practices and Supervision – BIS, 2009


A pillar of our ERM vision


A common foundation

Despite the multiple use cases, definitions, paradigms, users…

we believe in a common foundation for an ERM scenario analysis

solution:

•An advanced framework to define consistent and holistic scenarios

across products and across risk frameworks (e.g. Interest rate shock,

and credit migration)

•A front-end, integrated with our reporting services, to analyze, slice and

dice the portfolio

•A scenario manager interfaced with our different modules, providing SA

capabilities to the different analytics and products, and allowing

seamless interaction between the different components

•Powerful reporting capabilities


Our vision: a framework across the entire ERM

Single Obligor tools

(Ex: RiskAnalyst)

Economic data providers (Ex: MEDC)

Cre

dit Q

uality

drive

rs

Performance and capital forecasting tools

Portfolio tools

(Ex: RiskFrontier, CAD)

Po

rtfolio

d

rivers

Balan

ce sh

eet

drive

rs

Balance sheet tools

Holistic business forecasts

Adapters Adapters Adapters

Sce

nar

io s

erv

ices

an

d c

on

tro

l to

ols

Scenario repository and

framework

Adapters for economic data

Analysis tools

Scenario definition

tools

User rights and access

management


A best-in-class framework should

•Integrate from scenario delivery to performance forecasts

•While leveraging the power of each best-in-class engine

•Under a common framework, in order to:

• Consolidate, aggregate, share scenario definition and results

This includes what we call „vertical‟ and „horizontal‟ integrations

• Offer shared added-value tools for all scenario purposes

• Track progress; Audit & validate, override at any stage


The first deliverable: Scenario Analysis tool in the context of RiskAnalyst and RiskOrigins

RA/RO customers would benefit most from:

•Portfolio-level Stress testing capabilities

•Integrated analytical/OLAP reporting and portfolio-level analysis features

•Integration with macroeconomic scenarios, multi-period forecasts…

This will be done in a way that leverages the current data and models of

each customer - for both C&I and CRE portfolios


RA/RO

Interaction with RA/RO

•Bring in baseline data

•Drilldown, analyze portfolio

•Enter inputs on editable ratios

•Ask RA re-computation

•Analyze results

SAEBaselines

Analyze

portfolio

Enter inputs

Shifted inputs

Ratings

engine

computation

Results

Analyze

results


Easily synchronize and refresh base data

•Choose a range of statement and pick which kind of statements should be considered

•The most recent most reliable statement will be used as a basis for analysis (customizable)


Interactive definition of portfolios

•Pick any dimension to arrange and filter counterparties (location, industry, size…)

•Get dynamic feedback on the values of key indicators


Freedom to analyze portfolio data according to

•Any financial ratio or intermediate assessment from the rating model

•Using a drilldown across various dimensions (Location, Industry, Customer Size …)


Input stress-test or scenario assumptions

•On any component of the rating model

For instance, modify any quantitative/qualitative factor of RA‟s standard models (ex: for MM, Sales Growth, Debt ratio…)

•At any level of granularity

For instance, high-level aggregated inputs can be refined with counterparty-by-counterparty adjustments


Individual ratios can be changed at a very granular level:


Analyze and compare scenario results

•Straight from the definition and analysis screen

For easy fine-tuning of inputs, using a consistent view

•Using the dedicated reporting sections

Select multiple scenarios and compare raw data, scenario-transition matrices or graphical repartition of ratings


The deliverables

• Ability to produce the current reports (portfolio movement following PD/LGD adjustments)

• Ability to stress test the models – this will be the future need for any model

• Linking to the ERM framework going forward for comprehensive stress testing of the

portfolio


THANK YOU


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Documents

Scenario Analysis & Stress Testing...Apr 04, 2011 · Scenario Analysis for RiskAnalyst and RiskOrigins 6 There are issues with the current practices •Most solutions lack, in one