Financial Risk Manager Part 1
Get started today
Ultimate access to all questions.
Comments
Loading comments...
Ultimate access to all questions.
Sometimes, a moderately adverse scenario from the past is made more extreme by multiplying the movements in all risk factors by a certain amount. However, this approach assumes there is a simple linear relationship between the movements in risk factors. This is not necessarily the case, however, because correlations between risk factors tend to increase as economic conditions become more stressed.
A
One approach to scenario building is to assume that a large change takes place in one or more key variables. In general, as stress tests are designed to be forward-looking, it is useful to consider scenarios that have not necessarily occurred in the past.
B
Sometimes, a moderately adverse scenario from the past is made more extreme by multiplying the movements in all risk factors by a certain amount. However, this approach assumes there is a simple linear relationship between the movements in risk factors. This is not necessarily the case, however, because correlations between risk factors tend to increase as economic conditions become more stressed.
C
Sometimes, historical scenarios are based on what happened to all market risk factors over one day or one week (e.g., October 19, 1987 or September 11, 2001). These short-horizon stress tests can be supplements to stressed VaR and stressed ES calculations.
D
Senior management should challenge key assumptions in stress testing scenarios, or suggest new scenarios for consideration. Among other reasons, involving senior management in building scenarios makes it more likely that the stress testing will be taken seriously and used for decision-making.