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Learn / Risk & ALM

Stress testing

Stress testing asks a sharper question than a single shock. A shock says “move this factor.” A stress test says which question you are trying to answer, and what would count as a problem.

Three questions cover the classroom. What happened in a real episode? What if this stated mix happens? What mix would push the book through a limit you already chose?

01

Historical, hypothetical, and reverse

A historical scenario replays an actual episode. You take the factor moves from that window and apply them to today’s book. The lesson is how this book would have felt that episode. It is not a claim that the episode will repeat.

A hypothetical scenario is one you write down. The 10-year yield up 100 basis points, credit spreads up 50, equities down 20%, volatility up 10 points is a hypothetical mix. You chose the numbers. The market shocks page is where each piece of that mix gets a shape.

A reverse stress test starts at the bad outcome and walks backward. You do not begin with a favorite shock. You begin with a limit, and you ask which combination would break it.

Three stress questionsHistorical asks what happened in a real event. Hypothetical asks what if a named shock happens. Reverse asks what mix would breach a limit.Three stress questionsTeaching sketchHistoricalWhat happened then?Use a past eventHypotheticalWhat if this shock?You name the moveReverseWhat would breach?Start from the limit
Surplus starts at $8 million and the limit is $5 million. Any shock that marks surplus down by more than $3 million is a breach in this classroom.

02

One reverse example

Classroom surplus starts at $8 million. The limit is $5 million. The gap between them is $3 million. Any mix that marks surplus down by more than $3 million is a breach. A mix that marks surplus down by $2 million is uncomfortable and still inside the limit.

Finding that mix is the work. It might be a rate decline, because the liabilities are longer than the assets, so a rally in bonds can increase the liability value by more than the asset value. It might be an equity drop in the stock sleeve with no offsetting move in the liabilities. It might be both. The point of the reverse test is to name a mix that crosses $3 million, not to rank which future is likely.

03

Where the dollars are computed

This page stops at the question and the limit. The shock and net impact lab applies a hypothetical mix to a labeled book and shows the asset line, the liability line, the hedge line, and the surplus. Those dollars are teaching coefficients. They are the arithmetic of the lesson, not a capital model.