Conclusionzz

Due to the extreme price shocks experienced regularly in the world’s financial
markets VaR is not an adequate measure of risk. Stress testing must be used to
complement VaR. The primary objective of stress testing is to identify the scenarios
that would cause a significant loss and to put a limit on risk exposures that would
cause such losses.
Stress testing must be undertaken in a systematic way. Ad-hoc scenario tests may
produce interesting results but are unlikely to identify the worst-case loss a bank
could suffer. Care must be taken to identify the stress tests required by examining
the types of risk in the bank’s portfolio. Stress tests should be run daily as a bank’s
portfolio can change significantly over a 24-hour period.
A bank’s risk appetite should be set with reference to VaR and to the worst-case
loss a bank is prepared to countenance under extreme market conditions. This is
best done with reference to the frequency with which a certain loss can be tolerated.
Stress test limits can then be established to ensure that the bank does not create
positions that could give rise, in severe market circumstances, to a loss greater than
the bank’s absolute tolerance of loss. Stress testing should be an integral part of a
bank’s risk management framework and stress test limits should be used along side
other risk limits, such as VaR limits.