Top 3 approaches to reveal the inherent

weaknesses of financial portfolio

The recent recessionary waves have caused much stir in the financial market and

have pushed many leading institutions on the brink of going belly up. The

inflation, deflation debate continues unhindered without arriving at a logical

conclusion gold trading is taking at a pace that has surpassed previous trends.

This is a decisive point, particularly for managers of pension funds who need to

assess the catalysts that can trigger a negative trend for the fund in peculiar

situations. Portfolio stress testing is deemed suitable to ascertain potential

outcomes.

The approaches taken to test resilience to stress are varied.

• Historical test is a commonly preferred tool. The fund’s current portfolio

inclusive of liabilities and assets are projected on to a historical backdrop like a

previous stock market plummeting or credit crisis to assess the fund’s

performance if such a volatile situation is to hold sway of the market once again.

This hassle free approach is wanting of depth as the probability of exactly

emulating a given historic crisis seems quite bleak.

• The portfolio’s hidden risks are brutally exposed by another approach that

involves hard implementing measures. A particular portfolio risk measure report

is populated by static variables like the inherent relation between asset classes or

assets. The stress test is conducted by pushing the correlations to the extreme

ends of +1 and -1 to bring to light tail scenarios. The potential outcomes are

simulated to unearth the probability of considerable negative returns under given

correlation values. Volatility is another value that is stress tested to probe the

performance of a portfolio when volatility spikes. By combination of variations

in volatility to that of the correlation through a series of simulations will review

the inherent weaknesses of the portfolio.

The third approach takes resort to generation of potential scenarios for testing

stress prepared ness of the portfolio. This is an effort intensive exercise, but

the analysis is not limited to historical crisis only. The reviewer has to form a

mental picture based on the current scenarios about the ways in which the

events will unfold in the projected future and the impact of such events on the

portfolio. You can assume the relative strength of a particular currency against

the US dollar in future for-ex trading, the selling off of bonds at a given value,

the performance of high priced commodities like oil and gold, and reaction of

equities. The manager can generate a slew of potential outcome scenes to

evaluate the consequent impact on the portfolio.

Portfolios should be subjected toperiodical Portfolio Management to unearth

the vulnerable spots and inherent weaknesses to embrace corrective measures to

rectify the same and mitigate the effects. It only demands commitment, effort and

time on the part of managers to gain a comprehensive understanding.

CRE Portfolio Stress Testing by CEIS Review, Find more information

http://www.ceisreview.com/pages/Services/2/105/Loan_Portfolio_Stress_Testing

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