26 May Predicting the Pandemic
Last month we wrote about the massive upheaval caused by the coronavirus pandemic, and how financial institutions must quickly find an effective way to measure unprecedented tail risks.
The piece sparked a number of questions, which I’ll attempt to answer here. One client asked: Could you describe in detail how Straterix adjusted to the situation coronavirus created?
Our scenarios contained potential pandemic shock way before COVID-19. This was based on fears caused by SARS, as well as others that struck periodically since 2003. Now we find ourselves in a new pandemic scenario, the key unknown we need to know is what happens next, and the consequences it’s most likely to cause.
To do so, we first need to identify the full range of such consequences (rather than just a handful), adjusted to the unprecedented pandemic scenario that’s now unfolding (see image). This can be done by using artificial intelligence (AI) to generate a dense distribution of potential outcomes that incorporate all possible stages of the pandemic and the impact on the economy. Two of these could be:
- A second wave of infections, leading to an additional 20% drop in GDP and unemployment of 25%
- Development of a vaccine or cure, which means a 7.5% drop in GDP followed by a rapid recovery (3% GDP growth); while unemployment peaks at 20%, and recovers to 6-7% over the next three quarters.
Bottom-up economic and market forecasting produces limited views & risks missing significant impacts
Comprehensive scenario sets uncover hidden concentrations of risk
The More , The Better
We generate 10,000+ scenarios covering all such combinations and the respective values for yield and credit curves, currencies, equity and commodity markets, productivity in various industries etc.
For each financial institution, these outcomes are converted into their key performance indicators (KPIs) specific to their balance sheets and business strategies. These include net Income, capital and liquidity needs, credit losses and impact on earnings. This enables our clients to be prepared for all future outcomes while helping them to understand their respective probabilities.
Stay tuned for more on managing your balance sheet risk in the face of COVID-19. Or reach out to us at email@example.com
Alla Gil is CEO and co-founder of Straterix