Scenario Analysis and Stress Testing - Generating the Scenarios

4 important questions on Scenario Analysis and Stress Testing - Generating the Scenarios

What is the historical imulation approach for generating scenarios?

With historical simulation, we assume that days happened in the past are a good guide to what might happen in the comming days. If events have not occured in the past, they will not be occuring in the stress test.

What is conditional stress testing?


If scenario generated involves only a few "core" variables, regress other "peripheral"veraibles on the core variables to determine their movements

What is reverse stress testing?

Using alogorithms to search for scenarios where large losses occur!
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What are the incentives of a financial institution?

If stress testing committees come up with extreme scenarios, it is very likely that more capital is required. Therefore the committee has a scenario to water down all the scenarios they consider

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