Stress Testing
Stress testing evaluates portfolio or institution resilience under extreme but plausible adverse scenarios — market crashes, rate spikes, or economic shocks.
Concept map
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Definition
Stress testing evaluates portfolio or institution resilience under extreme but plausible adverse scenarios — market crashes, rate spikes, or economic shocks.
Use case
Used in risk management workflows, analysis, and technical interviews.
Judgment check
Useful only when the assumptions and inputs behind the metric are understood.
Deep dive
How to think about Stress Testing
Required for banks under Basel III and CCAR (US). Scenarios include historical (2008 crisis, dot-com bust), hypothetical (sovereign default cascade), and factor shocks (rates +300bps, equities -40%). Stress tests reveal hidden vulnerabilities and capital adequacy needs before crises occur.
Example: A bank's stress test shows that in a severe recession scenario with 10% unemployment and 50% equity decline, the bank would lose $50B but maintain capital ratios above minimums. This validates capital buffer adequacy or identifies shortfalls.