Macro stress tests and history‐based stressed PD: the case of Hong Kong
| Pages | 251-260 |
| DOI | https://doi.org/10.1108/13581980810888868 |
| Published date | 25 July 2008 |
| Date | 25 July 2008 |
| Author | Michael Chak‐sham Wong,Yat‐fai Lam |
| Subject Matter | Accounting & finance |
Macro stress tests and
history-based stressed PD:
the case of Hong Kong
Michael Chak-sham Wong
Department of Economics and Finance, City University of Hong Kong,
Hong Kong, and
Yat-fai Lam
Banking Policy Department, Hong Kong Monetary Authority, Hong Kong
Abstract
Purpose – The purpose of this paper is to discuss issues relating to stress testing methods for credit
risks in banks. Also, it suggests a solution to bank supervisors on evaluating stress test results.
Design/methodology/approach – Discussion is based on cases analysis on a stress period of the
Hong Kong banking sector.
Findings – The paper finds that econometric modeling does not work well modeling stress scenarios.
The stressed probability of default (PD) provided by Basel II would be much higher than stressed PD
observed in the history.
Practical implications – Bank supervisors should develop cost-effective methods to monitor the
stress test results reported by banks.
Originality/value – The paper addresses the issues of stress testing and provides a practical
solution for bank supervisors to monitor stress test results reported by banks.
Keywords Financial models,Financial institutions, Modelling,Econometrics, Stress, HongKong
Paper type Research paper
1. Introduction
Stress testing on the risk of credit portfolios is an important task for banks to comply
with the Basel II requirements. There is a wide range of practices among financial
institutions (see for instance, Bank for International Settlements, 2000; Financial
Services Authority, 2005; Hoggarth et al., 2005). Some bank supervisors have relevant
guidelines issued on stress tests, while others are still exploring suitable ways for their
supervised banks. Data is always a problem in stress testing the risk of credit
portfolios. Traditionally banks reported the ratio of nonperforming loans but banks are
now required to report probability of default (PD) or default rate measured by
“three-month past due”. These two sources of information are not the same. As many
banks do not have sufficient history of PD for building stress-testing models, this
makes stress testing a challenging task.
Some banks claim that they have successfully developed effective methodologies
to conduct stress tests and report their stressed loss estimates to bank supervisors.
The current issue and full text archive of this journal is available at
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The views and analysis in the paper are those of the authors and do not represent the views of
the Hong Kong Monetary Authority. Comments and enquiries can be sent to Michael C S Wong,
Department of Economics and Finance, City University of Hong Kong, Tat Chee Avenue,
Hong Kong.
Macro stress
tests
251
Journal of Financial Regulation and
Compliance
Vol. 16 No. 3, 2008
pp. 251-260
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581980810888868
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