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Conference Proceedings (1998), The Global Economy at the Turn of the Century-Volume II International Trade, pp. 601-615

Stress-Testing: Application of Extreme Value Theory to Foreign Exchange Markets

Risk management is especially concerned with catastrophic event such as stock market crashes, collapses of the bond market or foreign exchange crises. Risk management tools such as value at risk models have been developed both by professionals and academics to evaluate the risk of market positions. As most of VaR models consider "normal" market conditions, they are completed by stress testing studies focusing on catastrophic events. This paper proposes a rigorous method based on extreme value theory to define catastrophe scenarios used in stress testing methods. The stress value for a risk factor is computed for a given probability level, and inversely, a probability level is computed for a given stress value. An application is provided for foreign exchange markets.

LONGIN, F. (1998). Stress-Testing: Application of Extreme Value Theory to Foreign Exchange Markets. In: The Global Economy at the Turn of the Century-Volume II International Trade. pp. 601-615.