Economic Scenarios

Economic scenarios can be used for a variety of purposes. They can help assess the risks to business strategy and they can also be needed to fulfil regulatory requirements in measuring the impacts of adverse economic conditions upon business.

 

Businesses are interested in producing a picture of the future that represents an unlikely, yet feasible, unfavourable event. For any single series of interest, this can be a relatively simple process over a one-year horizon. For example, if businesses were just interested in GDP growth, and wanted to know the 1 in 25 chance worst case scenario for next year, one very simple way in which to arrive at a figure would be to take the lowest value observed over the last 25 years, namely the fall of 1.4 per cent in 1991.

 

This approach however fails to hold as soon as more than one variable is examined. For example, let us now assume that the business is interested in unemployment and GDP growth. The highest level of unemployment over the last 25 years was in 1986, when the claimant count was at 10.3 per cent. However, in this year GDP growth was positive, at 3.9 per cent.

 

Conversely, in 1991, unemployment was at the lower value of 7.5 per cent. Should the business therefore take 1991 or 1986 as the 1 in 25 year event? Or should perhaps the two bad events be combined and the worst of both be taken? This second approach is clearly not appropriate, as taking the worst case in both represents a state that is less likely to occur than once in every 25 years, specifically because it has not occurred in the last 25 years. However, without knowing how the variables are going to be used, it is not clear which of the two years is 'worse'.

 

Volterra's multivariate density estimation technique allows for this complex interaction between the variables, and captures a joint 1 in x year event for combinations of variables. We can cover a variety of UK economic performance measures, including GDP, Interest Rates, Inflation, Consumer Expenditure, Unemployment, Business Failures, Oil Prices and House prices. Read more about our Basel specific economic scenarios or download our service offering profile.