A Framework for Market, Credit and Transfer Risk Aggregation and Stress Testing

Abstract

A framework which consistently and fully integrates market, credit and country transfer risks of a general portfolio of financial assets in a multi-period setup is developed. An appropriate definition of exposure, loss-given-defaults and loss-given-transfer-events provides a unified treatment of these three risk types. Implementable algorithms are presented as well as a comparison with the industry standards and best practices. The framework discussed is generic and does not explicitly depend on the choice of the scenario generator. Generic and macroeconomical stress tests is directly obtained by selecting the paths for which the relevant risk factors are constrained by a priori given bounds.