RT Journal Article
SR Electronic
T1 Robust Risk Estimation and Hedging: <em>A Reverse Stress Testing Approach</em>
JF The Journal of Derivatives
FD Institutional Investor Journals
SP 10
OP 25
DO 10.3905/jod.2015.22.4.010
VO 22
IS 4
A1 Yaacov Kopeliovich
A1 Arcady Novosyolov
A1 Daniel Satchkov
A1 Barry Schachter
YR 2015
UL https://pm-research.com/content/22/4/10.abstract
AB The stress test has become an increasingly important risk assessment and management tool. But while it is easy to imagine a stress scenario and to estimate its impact on the firm’s financial condition, it is not so obvious how to select the most meaningful scenarios in the first place, either to get reasonable coverage of the space of stressful possibilities or even to focus on those that are most probable. In this article, the authors approach the problem from the reverse direction. They begin with a specified level of loss and pick the most likely scenario that generates that loss. They then use principal components to construct a set of alternative scenarios that produce the same level of loss but in (maximally) different ways. This provides much greater insight into which sources of risk are the most important and the most stable across scenarios.TOPICS: Risk management, quantitative methods