Why Banks Failed the Stress Test

Andrew G Haldane, Executive Director for Financial Stability, Bank of England: 

Back in August 2007, the Chief Financial Officer of Goldman Sachs, David Viniar, commented to the Financial Times: “We are seeing things that were 25-standard deviation moves, several days in a row.”

To provide some context, assuming a normal distribution, a 7.26-sigma daily loss would be expected to occur once every 13.7 billion or so years.  That is roughly the estimated age of the universe.   A 25-sigma event would be expected to occur once every 6 x 10124 lives of the universe. That is quite a lot of human histories.

When I tried to calculate the probability of a 25-sigma event occurring on several successive days, the lights visibly dimmed over London and, in a scene reminiscent of that Little Britain sketch, the computer said “No.”

Fortunately, there is a simpler explanation – the model was wrong.

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