Posted in Finance, Accounting and Economics Terms, Total Reads: 653
Definition: Stress Testing
A simulation system used on a company’s asset and liability portfolios to define their reactions to different financial conditions. Stress testing helps to determine how certain stressors (e.g. financial crisis) will affect a company, industry or a financial institution. In stress testing, changes in risk factors are considered over a single time step rather than evolutionary changes continuously.
The stress testing scenarios can be constructed in an ad hoc manner. It can also be systemized. An institution may identify certain fixed scenarios and perform periodic stress testing with those scenarios. It reflects the contingencies that are frequent apprehension of a management.
These form of tests can be applied to portfolios by investors to monitor the performance of returns. It can also be applied to banks by their risk management team or regulators to determine whether the banking system has enough strength to withstand the impact of adverse situations. The stress testing helps to detect the weak spots in the system at early stage to enable the managers or regulators to take preventive action.