Dissecting portfolio stress-testing

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Putting meaningful numbers to portfolio risks is challenging. Conventional risk measures are often considered not to fully capture all risks inherent in a portfolio, particularly under difficult market conditions. Stress-testing against significant historical market events, or using invented scenarios may help identify and quantify risks within a portfolio. Stress tests also help reassure a portfolio or risk manager as to how a portfolio might respond to specific market outcomes or other concerns.

This paper introduces stress-testing a portfolio against market risks using historical and artificial scenarios. It includes a definition of stress-testing and a classification, as well as thoughts on practical implementation. Four stress-testing methodologies are also explored.

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Q G Rayer (2015), Dissecting portfolio stress-testing, CISI, The Review of Financial Markets, issue 7, p2-7, September 2015.