Bottom-Up versus Top-Down Stress Test

From Open Risk Manual

Bottom-Up versus Top-Down Stress Tests

Bottom-Up versus Top-Down stress tests are distinguished in the context of Bank Stress Testing. The following table summarizes their relationship[1]

Aspect Bottom-Up Stress Test Top-Down Stress Test
Who is carrying out the test? By the firm itself By regulatory authorities / central banks
Who's assumptions is it based on? Firm's own assumptions or scenarios, with possible constrains by authorities General or systemic (macro-prudential) assumptions or scenarios designed by regulators and applicable to all relevant institutions
What data granularity does it require? Based on the firms’s own data and a high level of data granularity (possible use of external data) Based mostly on aggregate institution data and less detailed information
How comparable is it across firms? Little comparability as methodologies may differ substantially Enables uniform and common framework and

comparative assessment of the impact of a given stress testing exercise across institutions

Issues and Challenges

  • The terminology might be confusing as "bottom-up" methodology refers also to calculation approaches that focus on aggregating individual entity vulnerabilities as opposed to a top-down macro-economic view being propagated to the constituents of the portfolio (See Best Practices in Credit Portfolio Management)

References

  1. EBA/CP/2016/28

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