Finance and Economics Discussion Series (FEDS)
Enhancing Stress Tests by Adding Macroprudential Elements
William F. Bassett and David E. Rappoport
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
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