Systematictesting

From the previous section, it should be clear that a more comprehensive method of
stress testing is required. The methods so far discussed provide useful ways to investigate the impact of specific past or potential future scenarios. This provides
valuable information but is simply not sufficient. There is no guarantee that all
significant risk factors have been shocked, or that all meaningful combinations have
been stressed. In fact it is necessary to impose systematically (deterministically) a
large number of different combinations of asset price shocks on a portfolio to produce
a series of different stress test outcomes. In this way scenarios that would cause the
bank significant financial loss can be identified.
Stress testing is often only thought about in the context of market risk, though it
is clearly also just as applicable to credit risk. Stress tests for market and credit risk
do differ as the nature and number of risk factors are very different in the two
disciplines. Market risk stress testing involves a far greater number of risk factors
than are present for credit risk. Having said this it is clear that credit risk exposure
for traded products is driven by market risk factors. This relationship is discussed
further in the section on credit risk stress testing.