Portfolio Stress Testing
Portfolio stress testing is a means of identifying unusual circumstances that could lead to larger than expected losses. It frequently takes the form of scenario analysis or a simulation of historical or hypothetical events.
In a scenario analysis, stylized scenarios ranging from modest to extreme outcomes are modeled individually. For example, scenarios could include a 10-basis point interest rate move in either direction, a 100-basis point move in either direction, and a steepening or flattening of the yield curve. By using standard measures such as these, scenario analysis can facilitate risk comparisons across assets. However, it does not account for correlations between risk exposures - for example, the effect of both a 100-basis point move in interest rates and a steepening yield curve would not be known.
Simulation of hypothetical or actual historical events is used to see how the entire portfolio would perform when subjected to a given set of extreme conditions. It is particularly useful when extreme breaks (price gaps) are considered more likely that the model being used assumes.
For more information, see all articles on: Governance, Portfolio Management, Risk Management See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
