Improvising a stress test helps an investor in identifying the risk
factors affecting a portfolio and positions themselves in such a way so as to
mitigate the identified risks.
Improvising a stress test helps an investor in identifying the risk
factors affecting a portfolio and positions themselves in such a way so as to
mitigate the identified risks. Portfolio stress testing seeks to study
the adverse effects of financial downturns, loss strategies and to strengthen
the business under varying economic climates.Stress testing involves analyzing
the impact of various risk factors in one’s portfolio and estimate the
potential loss to a portfolio under adverse economic circumstances. There are
methods and strategies to apply this technique and let us see what they are:
Historical Stress Testing:
Historical stress testing is intended to gauge the health of a
portfolio. The portfolio manager identifies an adverse event that has occurred
in the past and has affected the economy as a whole. An example of this could
be the Sub-Prime Crisis or the 9/11 attacks. After identifying an event, the
portfolio manager then proceeds to apply the same to his portfolio and gauges
the impact of the same on his portfolio. The main advantage of using the
historical method is that the events identified under this method have actually
taken place at some time in the past. However, care must be taken to identify
and use such historical events which would have relevance to the portfolio in
question.
Customized Stress Testing:
Whether an event that has taken place is the past is likely to recur or
not remains unknown. As such, the historical stress testing may actually be for
a scenario which may never occur in the future. Besides, new financial
instruments are developed which get added to one’s portfolio. As such, the use
of historical stress testing may not be appropriate since in the past these new
financial instruments would not have existed. To overcome these limitations,
Customized portfolio stress testing is used. These are tailor-made to
assess the impact of risk factors if some specific adverse event were to
happen. These tests are generally developed in relation to those scenarios
which are likely to have a material impact on the portfolio.
Reverse Stress Testing:
Historical tests and Customized tests indicate the potential loss
suffered if an adverse event pans out. They give an estimate of the loss on an
adverse event materializing. Reverse testing on the other hand tries to arrive
at an event that would lead to the failure of an organization on the whole.
Reverse testing involves identifying the risks involved in a possible course of
action that would lead an organization to its doom. However, reverse tests involve a lot of
thought process and since they begin from the scratch and seek to identify the
roots of the problem, they are often construed to be very laborious.
Portfolio stress testing is essential to the banking sector to estimate the risks involved in
the portfolio of the advances held by the
bank and seeks to capture the risks to the various asset classes comprised in
the portfolio in case of economic adversities.
CRE Portfolio Stress Testing - CEIS can assist in
creating an effective and manageable stress testing process and framework.
No comments:
Post a Comment