Fishing for Complements

Sep 1, 2008

A survey of stress testing practices in 2005 stated that stress testing serves as "a complement, rather than as a supplement" to other risk management tools. As we tour stress testing practices, we begin with those that do no more than make up for basic flaws in statistical models, without adding much to our understanding of the flaws in our portfolio. Where there is power in stress testing is where we already have confidence in a statistical loss estimate, and can better characterize the sorts of events that will lead to the worst losses, and ultimately, where we can start to ask not just what might happen to us, but how we might react. There is the potential that stress tests are truly complements, but it is hard to argue that all of today's practices achieve this.