Value at risk (VaR) techniques have been a mainstay of financial risk management since the 1990s. If a bank uses a 99% confidence level to calculate its value at risk, it generally expects to suffer a loss exceeding the VaR on one day out of every 100. What happens, however, on the one day when the VaR is exceeded? How large is the loss on this day? Could this be the one bad day required to 'break the bank'? The criticisms that VaR was poor at estimating risk under non-normal conditions were seen as somewhat academic during the benign financial conditions of the early years of the century. However, there has always been an understanding of the need to go beyond VaR methods in order to gain a more holistic view of risk exposures. By its nature, stress testing compels risk managers to assess linkages between events and to more fully understand the nature of risk exposures. The global financial crisis damaged the reputation of some risk measurement techniques, including stress tests. However, the response has been not to abandon stress testing but instead to strengthen and extend it. This course describes how the practice of stress testing has developed within financial risk management in recent years and highlights its growing importance following the events of the crisis. It also addresses the different types of stress test in terms of both institutional and regulatory contexts.
Prior to completing this course it is recommended you undertake:
This online course forms part of the Intuition short course suite.