Predicting European bank stress tests: Survival of the fittest
This paper tests the hypothesis that stress tests are primarily a function of the fundamental financial condition and operating environment of individual banks, rather than alternative adverse economic and financial scenarios imposed by regulators. We develop a novel early warning system based on multiple strategy ensemble methods to predict whether European banks pass stress tests in 2010, 2011 and 2014. The model is able to identify over 98% of failing and passing banks in the training subsample and predict about 90% of banks in the test validation sample. Further analyses of predictor importance and robustness compared to other competing model approaches are conducted. Our evidence supports the conclusion that, regardless of different macroeconomic scenarios, surviving stress tests depends largely on the underlying risk dimensions of individual banks.