Stress Testing: The Use and Abuse of “Intuitive Signs” on Credit Model Coefficients

In the past week, I have spoken with many regulators and bankers on the proper role of intuition in the econometric estimation of credit models for the Federal Reserve’s Comprehensive Capital Analysis and Review 2015. In our review ofbest practices for stress testing , value at risk, and credit value at risk on October 20, 2014, there was no role for “intuition,” just for science. The same is true for our November 13, 2014 update of model validation procedures for CCAR 2015

Why? In quotes from Kathryn Schultz, Nobel Prize Winner Daniel Kahneman, and Professors King and Soneji below, we explain that the very DNA of human beings leads us to be overconfident in our own intellectual powers. Rather than relying on modern econometric methods, most humans would rather guess an answer and would normally be supremely confident in its accuracy.

 

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