Ramadiah, Caccioli & Fricke’s research offers supervisors valuable insights into conducting more accurate stress tests. 

FNA’s Amanah Ramadiah and researchers Fabio Caccioli and Daniel Fricke offer supervisors valuable insights into conducting more accurate stress tests in the 2021 paper, ‘Reconstructing and Stress Testing Credit Networks’ which underlines the importance of understanding the consequences when taking a specific set-up when conducting stress tests, especially when data is incomplete. 

Despite many proposed financial network reconstruction methods, questions remain over which can best and most accurately reproduce a financial network suitable for conducting a stress test. As a key source of systemic risk, supervisors must use the most appropriate tools to reconstruct financial networks and yield accurate results. 

To investigate which method works best, the researchers perform a horse race to test four methods’ ability to reproduce the topological features of a credit network and the actual level of systemic risk. 

In many cases, the best method for reproducing the topological features of the network depends on the assumed criterion; however, in most instances, the chosen methods tended to underestimate systemic risk. 

The paper also explored the impact of specific policies proposed to make the financial system less vulnerable, such as merging or breaking up banks and can be read in full here