Stress-testing macro stress testing: does it live up to expectations?

Abstract:

We critically review the state of the art in macro stress testing, assessing its strengths and weaknesses. We argue that, given current technology, macro stress tests are ill-suited as early warning devices, ie as tools for identifying vulnerabilities during seemingly tranquil times and for triggering remedial action. By contrast, as long as properly designed, stress tests can be quite effective as crisis management and resolution tools. We also see additional side benefits, stemming largely from the way such tests can discipline thinking about financial stability. We suggest possible ways to improve their performance.

JEL Classification: E30, E44, G10, G20, G28

Keywords: stress tests, financial instability, macroprudential