CCAR requires banks to stress test their portfolios based on proposed variables:Real GDP growthNominal GDP growthReal disposable income growthNominal disposable income growthUnemployment rateCPI inflation rate3-month Treasury rate5-year Treasury yield10-year Treasury yieldBBB corporate yield Mortgage rate Prime rate Dow Jones Total Stock Market Index (Level) House Price Index (Level) Commercial Real Estate Price Index (Level) Market Volatility Index (Level)How it can be estimated the impact of these variables on financial instrument depending on underlying U?Through correlations???For example, how do I perform a stress test scenario on a 1M European Option on USDEUR Spot?Thanks!

Doubled.

Translate the economic scenarios into changes of market factors (somehow subjective), using a good deal of historical analysis and correlations to justify the assumptions made.In your example you will estimate changes in thje FX rate, vol and IR levels.

Thanks qhedge, I had the same thougts...I guess this is why the banks are trying to figure it out...

Not long ago in his NYT blog, Paul Krugman stated his opinion that he does not understand why unemployment remains such a persistent problem. Further, he argued that no other economist does and, further yet, that Janet Yellen and Charles Plosser do not know either. Nobody has this problem figured out according to Krugman, arguably the world's most successful contemporary economist. I believe him, the evidence is before everyone's eyes.Yet somehow banks are supposed to figure this all out in their stress testing?Imho the macroeconomic obsession within the regulatory community (motivated by their fear of global financial contagion) will likely prove to be their second great mistake, the first being the entire internal models approach. Risk managers who are now required to spend so much of their time modelling essentially indeterminate things could easily end up taking their eye off the ball in areas where they could add value. Better policies and procedures and better enforcement of such has way better bang for the buck than macroeconomic modeling, in my opinion. The recent great disaster in the US was essentially due to incentive problems and a lack of compliance/enforcement - no amount of macroeconomic modeling would have helped predict or prevent that.They don't call economics the dismal science for nothing. I am not saying that macroeconomic modeling is worthless but I am saying that it is not worth very much and that there are more useful things to do in risk management. I hold no monopoly on the truth but came to my views honestly with 25+ years of experience in trading, economics and regulation, been there, done it all, now can sit back and wax philosophical about it.

QuoteThey don't call economics the dismal science for nothing. It's a fiasco. QuoteHouse Price Index (Level) Commercial Real Estate Price Index (Level) Can of worms.

QuoteOriginally posted by: horacioaliagaCCAR requires banks to stress test their portfolios based on proposed variables:For example, how do I perform a stress test scenario on a 1M European Option on USDEUR Spot?We interpolate TSY curve given the three TSY rates, then forecast the spread to libor/swap (OIS) to build the forward curve for future quarters, let's say 2015Q4. Then you plug the forward curve into any interest model.So, the trick y thing is to forecast the spreads using 28 macro series (you only listed domestic variables). There's a ton of ways of doing this, it's mostly time series forecasting such as ARIMAX, State-Space Models, BVAR. Sometimes cross-sectional models work too. It's a big topic, really.