Stress testing

Applying specific severe scenarios to a portfolio and measuring the result, rather than relying on a statistical distribution.

The scenarios can be historical, such as repeating a known crisis, or hypothetical, such as a currency move combined with a rate shock.

The advantage over statistical measures is that stress testing does not assume the future resembles the sample. Its weakness is that the scenarios are chosen by people, and the scenario nobody imagined is the one that arrives.

Ask what would have to happen for this portfolio to lose half. Then ask how likely that is.