The recent global financial crisis painfully revealed the need for better, more comprehensive stress testing in the financial industry. Stress testing focuses on analyzing risks associated with rare or extreme – but still relevant – events. Even if something that could go wrong never materializes, firms should still have a contingency plan for such events (i.e., a firm’s response to Murphy’s Law). A stress test is the foundation for this contingency plan, and serves to answer two types of questions:
- How much could I lose under certain stress scenarios?
- How could I lose more than X dollars?
Antonis Miniotis is a Solutions Architect in the Americas Risk Practice at SAS. He and I co-authored a white paper that discusses the motivation for stress testing and describes the role it plays in the management of risk. The paper also provides insight into the different types of stress tests firms commonly employ – such as sensitivity analysis and scenario analysis. Further, it illustrates the importance of integrating stress test measures with value at risk (VaR) measures for financial and operational risks. We also describe important risk architecture and data management considerations. Download the white paper Stress testing: A board-level issue.