Stress testing

What it means

Revaluing a portfolio under severe but plausible scenarios, rather than under the distribution of ordinary days.

The exam angle

Complements VaR instead of competing with it: VaR describes the usual, stress testing the unusual. Reverse stress testing starts from the failure and asks what would cause it.

Where it appears in the syllabus

• Market Risk Measurement & ManagementFRM Part II · exam weight 20% · VaR and ES estimation, backtesting, EVT, GARCH, copulas, FRTB.
• Current Issues in Financial MarketsFRM Part II · exam weight 10% · This cycle's readings — AI in finance, climate risk, digital assets, bank stress.
• Foundations of Risk ManagementFRM Part I · exam weight 20% · Risk taxonomy, governance, CAPM, multifactor models, financial disasters.

Related terms

• BacktestingComparing realised losses with the VaR forecasts that preceded them, to check that breaches occur about as often as…
• Coherent risk measureA risk measure satisfying monotonicity, subadditivity, positive homogeneity and translation invariance.
• Expected shortfallThe average loss in the cases where the VaR threshold is breached — the expected size of a bad day, given that it is a…
• Value at RiskThe loss that will not be exceeded over a stated horizon with a stated confidence — for example, a 1-day 99% VaR of…
• Basis riskThe risk that a hedge and the exposure it hedges do not move together, leaving a residual.
• Carry tradeBorrowing in a low interest rate currency to invest in a high interest rate one, profiting if the exchange rate does…