Coherent Stress Testing: A Bayesian Approach to the Analysis of Financial Stress

“Rebonato’s refreshingly original book is the most significant advance in financial risk management in many years. It is rigorous yet thoroughly practical, proposing an operational Bayesian framework that complements purely statistical approaches with the causal/economic structure needed for coherent stress testing. Prominently displayed and mixed beautifully throughout are both the expansive wisdom of a serious scholar, and the pragmatic applied sense of a seasoned industry veteran. Rebonato has defined the new frontier of best-practice financial risk management. I am open-mouthed with admiration.”—Francis X. Diebold, Paul F. and Warren S. Miller Professor of Economics, Co-Director, Wharton Financial Institutions Center, Professor of Finance and Statistics, University of Pennsylvania“Risk management is at a crossroads. The ‘certainty’ provided by statistical analysis of historical data has been shown to be an illusion. The challenge is how to inject a dose of judgment but not revert to pure subjectivity. There is no clear answer, and a reliable guide is required to navigate what can be a minefield. Fortunately Dr. Rebonato has used his unique combination of technical skills and experience to explain what can cannot be done using stress testing. Anyone who is interested in combining the best aspects of statistical analysis and disciplined subjective judgment should read this book.”—Ian Cooper, Professor Finance, London Business School“Wall Street goes Bayesian! Theses methods have long been used as a standard technique in reliability engineering and operations research, now this book introduces Bayesian nets as a stress testing tool for the financial industry. Every quantitative risk manager ought to be aware of their potential: this is an excellent start.”—Paul Embrechts, Department of Mathematics and RiskLab, ETH Zurich“Stress tests are essential complements to VaR models, which are inadequate for very rare events. In practice, however, scenarios can be difficult to handle because they are typically not associated with a probability. This book shows how to build subjective, yet consistent probabilities for scenarios. Highly recommended.”—Philippe Jorion, Professor, University of California at Irvine

About the Author

DR. RICCARDO REBONATO (London, UK) is Head of Front Office Risk Management and Head of the Clients Analytics team at BGM RBS. He is visiting lecturer at Oxford University (Mathematical Finance) and adjunct professor at Imperial College (Tanaka Business School). He sits on the Board of Directors of ISDA and on the Board of Trustees for GARP. He is an editor for the International Journal of Theoretical and Applied Finance, Applied Mathematical Finance, Journal of Risk, and the Journal of Risk Management in Financial Institutions. He holds doctorates in Nuclear Engineering and in Science of Material/Solid State Phsyics. He was a research fellow in Physics at Corpus Christi College, Oxford, UK.