Dynamic stress-testing and shock event calibration

As market volatility patterns shift, geopolitical tensions persist and monetary policy paths diverge, and so risk frameworks within organisations need to adapt. Senior market risk leaders at Risk.net’s Leaders’ Network meeting held in London in June delved into scenario design, stress-testing, model governance and the increasing interplay between market and counterparty risk in today’s environment. Leaders shared insights, challenges and strategies related to the evolving landscape of market risk management.

Key takeaways:

• The complexity of stress-testing frameworks can hinder effective risk management; simplifying these frameworks is essential for clarity and focus.
• Institutions often fall into the trap of overcomplicating stress tests, leading to frameworks that are too complex for meaningful analysis.
• There is a growing need to differentiate between regulatory stress-testing and internal risk management practices to balance compliance with effective risk management.
• Engaging with expert councils and fostering collaboration across departments can enhance the quality of stress-testing by incorporating diverse perspectives.
• The importance of narrative in conveying stress-test results to senior management is crucial; effective communication helps ensure risk insights are understood and acted on.
• Calibration of stress tests to account for unprecedented market events poses significant challenges; innovative approaches to scenario analysis are necessary.
• Relying solely on historical data can lead to a narrow view of potential risks; incorporating hypothetical scenarios is vital for preparing for unexpected events.
• The unpredictability of market events necessitates a proactive approach to risk management, with a focus on preparing for a range of outcomes.