Application to stress testing models

Stress test models can be particularly complex for the following reasons:

Multiple inputs of different nature must be used to provide an outcome
Statistical – mathematical complexity with low possibility of benchmarking due to the specific features of the financial institution
Predictive model and as such all the classic issue associated with it
Key in supporting the capital and strategic decisions and as such a robust internal challenge is required to validate their outcomes.

As consequence, the validation of the stress test model could be challenging, and it requires to focus on many aspects including the following:

Consistency of scenarios and assumptions across all the models
Appropriate segmentation of exposures to verify that the appropriate risk factors are applied
Relevance of 3^rd party vendor: this is extremely important point as the regulators are expecting that a financial institution validates the internal use of a vendor model
Sensitivity analysis around assumptions to assess materiality on the model outcome
Model weakness vs expert judgement: it is important to evaluate the materiality of the model weakness, any associated overlay and the supporting analysis to determine the amount of the latter.