Stress Testing and Other Risk Management Tools

Akhtar Siddique and Iftekhar Hasan

The later chapters of this book will focus on various elements and aspects of stress testing. Although stress tests have gained in prominence since the financial crisis of 2007–09, stress testing existed in the arsenal of risk managers well before the financial crisis. However, it has not existed in isolation: along with stress tests, risk managers have always used other tools.

Quite sophisticated stress testing existed in many banks’ management of market risk before the 2007–09 crisis, and it often focused on the trading book, including both transaction and portfolio-level stress testing. In contrast, the stress testing of credit risk was more likely to be at a transaction level. Portfolio-level stress-testing was often rudimentary, if it existed all. Enterprise-wide stress tests also tended to be rudimentary (with one or two notable exceptions), especially for institutions that had large banking books.

Risk management in financial institutions has always relied on a panoply of tools and measures. Textbooks on risk management at financial institutions describe various other tools, such as position limits and exposure limits, as well as limits on the Greeks, including delta