Stringent Stress Tests
- Topics:
- Enterprise Risk Management
- Source:
- Incisive Media
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Overview: Ever since the collapse of Long-Term Capital Management, risk departments have expended significant resources to make stress tests a tool that can be used in conjunction with value-at-risk (VAR). In this paper, the characteristics of good (and bad) stress tests are characterized, as well as some of the nagging issues facing risk managers who are trying to make stress tests useful. VAR reflects price behavior in everyday markets, but may not reflect what happens during abnormal events. VAR provides no information on the direction of risk exposure. VAR does not provide information on the potential magnitude of losses when the VAR measure is exceeded. It is widely agreed that stress tests can address some of the shortcomings in value-at-risk estimates, but stress tests have their own problems. Some of the problems with building good stress tests can be dealt with, given sufficient resources. As to methods proposed for alleviation of the remaining problems, the jury is still out. The above discussion suggests that, while the benefits of using stress tests are real, a healthy dose of circumspection should accompany the use of stress test in risk management.
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Format: HTML | Date: Jan 2003 | Pages: 1
