Working Paper

Enhancing Stress Tests by Adding Macroprudential Elements

Abstract: The use of stress testing for macroprudential objectives is advanced by modeling spillovers within the financial sector or between the real and financial sectors. In this chapter, we discuss several macroprudential elements that capture these spillovers and how they might be added to stress test frameworks. We show how funding spillovers can be modeled as an add-on, using a reduced-form relation between banks' funding cost, bank capital and economic activity. Using a calibration to US data, we project very modest funding spillovers conditional on the DFAST 2018 severely adverse scenario. We describe the pros and cons of modeling different types of spillovers using this approach.

Keywords: Bank capital; Funding shocks; Macroprudential policy; Stress testing;

JEL Classification: E58; G28;

https://doi.org/10.17016/FEDS.2022.022

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2022-05-06

Number: 2022-022