Lasso Regressions and Forecasting Models in Applied Stress Testing

Abstract

Cover -- Contents -- Introduction -- Stress Tests: A Multi-Step Process -- Model Selection Challenges in Stress Tests -- Machine Learning: The Interpretability-Flexibility Tradeoff -- Linear Models: Subset Selection and Shrinkage Methods -- Lasso Applications in Finance, Economics, and Financial Networks -- A Stress Test Application: Forecasting Probabilities of Default -- Conclusions -- References -- Figures -- 1. Geometry of Least Squares, Ridge Regression and Lasso regression -- 2. Lasso and relaxed Lasso, mean squared errors -- Tables -- 1. Lasso and relaxed lasso, coefficient estimates, λ-min specification -- 2. Lasso and relaxed lasso, coefficient estimates, λ-1se specification