Portfolio Stress-Testing

Meet regulatory requirements, evaluate the impact of shocks and develop strategic business plans.

At Moody's Analytics, our team of more than 80 economists employ a holistic and fundamental approach to stress-testing. We focus on the underlying drivers of portfolio performance and link these drivers to alternative scenarios based on a range of possible outcomes given the current business cycle. 


Linking performance drivers to global and local economic activity, our stress-testing approach generates more realistic and flexible scenarios that can be used to assess the efforts of performance of sovereign defaults, energy crises, and even of more discrete factors such as the nature and pace of an economic recovery.

We produce fully-fledged economic scenarios based on projections provided by local authorities, custom/idiosyncratic scenarios, as well as standard scenarios that align with probability distribution of economic outcomes, as example:

  • S1 - Stronger Near-Term Rebound
  • BL - Baseline Forecast
  • S2 - Slower Near-Term Recovery
  • S3 - Moderate Recession
  • S4 - Protracted Slump
  • S5 - Below-Trend Long-Term Growth
  • S6 - Oil Price Increase, Dollar Crash
  • S7 - Next-Cycle Recession (US Only)
  • S8 - Low Oil Price

Stress-Testing Answers the Right Questions

Beyond meeting regulatory requirements, stress-testing helps management answer "What if?" questions enabling improved portfolio management. Based on the results of stress-testing, management can take strategic actions such as adjusting economic capital levels, adjusting portfolio mix, raising or lowering lending standards, and others that will result in enhanced economic returns.

Our forecasting models provide the foundation for portfolio stress-testing including gross shock and scenario analysis and employ a consistent and realistic modeling approach across all asset classes to help you answer questions such as:

  • How will I meet regulatory requirements for stress-testing?
  • How should I adjust lending standards if the economy goes into a double-dip recession?
  • Could my portfolio withstand a sovereign default event in Europe?
  • What impact would a prolonged deflation cycle have on current and future loan performance?

Custom, Forward-Looking Solutions

We offer a range of services to help you stress-test your portfolio. From our macro and regional forecast databases with alternative scenarios to customized models built on your unique portfolio and internal drivers, we can work with you to develop the solution that fits your specific needs. Our solutions include:

  • Off-the-shelf or bespoke alternative economic scenarios
  • Economic Scenario Generator for Solvency II
  • Calibration services to incorporate macroeconomic variables in existing models
  • Stress-testing and loss forecasting capabilities across:
    • Capital markets
    • Consumer credit and retail banking
    • Structured finance securities
    • Corporate loans
    • Commercial real estate
  • Asset management

Today more institutions are looking to analyze how changes in the economy can affect credit portfolio risks, whether a firm remains adequately capitalized during all phases of an economic cycle and in stress scenarios, how much a firm may lose in a stress scenario, the degree of impact of imprecise risk factors (risk drivers – interest rates, exchange rates, default risk, migrating and correlation).

OUR APPROACH

  • Forward-looking: It does not assume that future recessionary episodes will track past ones. We customize a set of fully specified economic scenarios based on suggestions and expertise from our 60+ economists.
  • Flexible and Transparent: It is flexible in that it allows the creation of a fully customized solution. Our theoretical approach is fully specified, equation outcomes are transparent, and, when necessary, further calibration on the models is performed to meet the clients' needs.
  • Customized: Our solution is tailored to mimic our clients' portfolio strategies and their key risks. Additionally the stressed scenarios will be developed in line with our clients' unique regional and industry exposures.

Our Economic and Credit Advisory team helps our clients implement modeling, forecasting and stress-testing frameworks by incorporating and linking off-the-shelf and bespoke alternative scenarios across their clients' portfolios:

  • Financial Metrics: An integrated framework, where the background macroeconomic scenarios are fully calibrated to reflect our alternative assumptions on the relevant risks to the Moody's Analytics baseline forecast. Key macroeconomic series are then correlated to the relevant financial and credit metrics to produce the output results (e.g., yield and swap rate curves, risk-free rates, CDS spreads, rating migration, equity indexes, etc.).
  • Rating Transitions: We can stress-test rating migrations for any portfolio of corporate (financials and non-financials) and sovereign bonds. The migration information can be provided by internal rating models and/or using Moody's transition data. Our approach: Dynamic panel data models to capture the behavior of transition matrices over time. This exercise allows us to quantify the sensitivity of migrations to changes in macro and financial series.
  • Credit Portfolio Risk Optimization: Beyond regulatory driven stress-testing exercises such as CCAR, many of our clients use our economic and credit expertise for portfolio risk optimization projects and strategic planning. In such projects we help investment strategy and risk teams to stress portfolios under different custom scenarios in order to provide investment criteria recommendations in line with the client risk appetite and investment objectives. These exercises are particularly popular among our asset management and insurance clients who may be required to divest under their credit investment policy should certain shocks affect the ratings of their assets.
  • Economic Scenario Generator Engine for Solvency II: Economic Scenario Generator is the cornerstone of a market-consistent valuation of the balance sheet. In particular, Economic Scenario Generator represents what we consider to be the appropriate tool to properly monitor and manage both market and credit risk from an integrated perspective. Our clients can benefit from our Economic Scenario Generator service in two ways; by being delivered custom outputs from our in-house model or by implementing our Economic Scenario Generator engine within their existing platforms and therefore being in full control of the process.