What you will learn
- Correlation shifts
- Gap scenarios
- Margin pressure
- Drawdown sequences
Correlation shifts
Stress tests define hypothetical changes in prices, volatility, liquidity or funding. They reveal consequences under assumptions, not the maximum conceivable loss. Include why each scenario is relevant to the portfolio.
Gap scenarios
Joint shocks should consider relationships that may change. Assuming the same diversification offsets in every stress can understate combined loss. Examine correlation convergence or simultaneous adverse moves where plausible.
Margin pressure
Liquidity stress includes wider spreads, reduced executable size and delayed exits. A mark-to-model loss can differ from the cost of actually reducing the portfolio. Include the need to transact across all relevant legs.
Drawdown sequences
Funding stress concerns cash requirements and access over time. A position may have a tolerable eventual valuation but an unaffordable interim obligation. Keep cash-flow timing separate from terminal P&L.
Worked example
Two positions usually offset, but a stress scenario makes both lose 50 while exit costs rise to 10 each. Combined scenario loss is 120, not the near-zero value suggested by their normal offset.
Try it yourself
Calculate the combined loss if one position loses 70, the other 30 and each costs 8 to exit. State one limitation of the result.
Show the worked solution
The scenario loss is 70+30+8+8 = 116. It is conditional on the assumed shocks and exit costs, not a guaranteed bound; worse liquidity or different joint movement could produce another result.
Apply this to your course project
Produce a scenario-based portfolio risk dossier.
Keep the calculation inputs, assumptions and decisions with your work. Practical exercises are self-reviewed; the scored knowledge checks assess the questions shown, not an independent certification of practical competence.