Constructing a Stress Test

Overview

Stress testing can be a rather resource intensive activity. Unlike VAR, which can largely be automated, stress testing mostly involves resources actively participating in formulating scenarios and whatever analysis required to understand the outcomes.

This process of management actively thinking about the tail risk scenarios is often beneficial beyond the results of any given stress test.

Steps to Constructing a Stress Test

• Formulate a set of Worst Case Scenarios - sometimes the scenarios will be provided for the bank, but the process of formulating a scenario can be beneficial to the bank managers.
• Forecast an Expected Outcome of each Scenario