Learning objectives: Describe the key elements of effective governance over stress testing. Describe the responsibilities of the board of directors and senior management in stress testing activities. Identify elements of clear and comprehensive policies, procedures, and documentations on stress testing.
Questions:
800.1. In the wake of the global financial crisis (GFC), stress testing has received prominent media attention. Siddique and Hasan explain that "stress testing has many approaches. For example, at many institutions, finance and treasury have had ownership of the budgeting process. Hence, centralized stress testing could be housed in such a central function. Other institutions have taken a more decentralized approach, wherein the central function has only acted as an aggregator. Effective stress testing does not need a given organisational form or approach. However, a given organisational form will require certain aspects to ensure effectiveness. For example, in a decentralized approach towards stress testing, consistency across the organisation becomes important, and the institution will need to find ways of ensuring that consistency."
Each of the following statements is true about stress testing EXCEPT which is false?
a. Stress testing is a non-statistical risk measure that may employ scenario analysis as one approach
b. An acceptable proxy for stress testing is to generate value at risk (VaR) with a series of progressively increasing confidence levels; e.g., 99.0%, 99.50%, 99.75%, 99.90%, and 99.99%
c. While backtesting validates model parameter(s) using a large number of actual, historical observations; stress testing on the other hand uses a small number of extreme movements in market variables
d. Unlike value at risk (VaR) which indicates neither the magnitude nor shape of extreme losses beyond the VaR threshold, stress testing DOES attempt to characterize the magnitude/shape of the extreme loss tail
800.2. Phillip is developing a "Roles and Responsibilities" framework for his firm's stress testing program. His checklist includes the following key responsibilities:
I. Perform regular reporting of stress-testing results
II. Ensure alignment between firm's risk appetite and stress testing activities
III. Ensure the firm's stress test exercises are all built on identical assumptions and utilize the same information and inputs
IV. Should be at least well-versed, if not expert, in the details of stress testing and be able to drill down to discuss technical details and challenge exercise results on a granular level
Between the board and senior management, who has primary responsibility of the above activities?
a. I. Board, II. Management, III. Both, IV. Both
b. I. Board, II. Management, III. Both, IV. Neither
c. I. Management, II. Management, III. Board, IV. Board
d. I. Management, II. Board, III. Neither, IV. Management
800.3. Zotstreet International is an international financial services firm. The key elements of of its stress testing program include: (i) a governance structure; (ii) policies and procedures; (iii) validation and independent review; and (iv) internal audit. The firm's stress testing policies are approved and annually reassessed by the board. The stress test results are considered directly for decisions relating to capital and liquidity adequacy, including capital contingency plans and contingency funding plan. The firm conducts stress tests internally, under the direction of the Chief Risk Officer (CRO) and her staff in the risk management function, but also retains a third-party vendor to conduct complementary stress tests. The third-party's approach invokes proprietary intellectual capital such that the details of their approach are neither documented nor available for review by Acme, but the summary results are disclosed. Management gives the firm's risk managers (in the risk management function) the flexibility to conduct ad hoc stress tests in order to address rapidly emerging risks and vulnerabilities.
Based on these summary facts, which of the following statements is most TRUE about Zotstreet's stress testing program (best answer please)?
a. Zotstreet appears to have a deficiency with respect to documentation
b. Zotstreet should not be delegating any stress testing to a third party
c. Zotstreet approach appears to generally reflect best practices and include all of the key elements of an effective governance over stress testing
d. Zotstreet approach appears to generally reflect best practices EXCEPT the board should re-assess the firm's stress testing policies at least once per quarter
Answers here:
Questions:
800.1. In the wake of the global financial crisis (GFC), stress testing has received prominent media attention. Siddique and Hasan explain that "stress testing has many approaches. For example, at many institutions, finance and treasury have had ownership of the budgeting process. Hence, centralized stress testing could be housed in such a central function. Other institutions have taken a more decentralized approach, wherein the central function has only acted as an aggregator. Effective stress testing does not need a given organisational form or approach. However, a given organisational form will require certain aspects to ensure effectiveness. For example, in a decentralized approach towards stress testing, consistency across the organisation becomes important, and the institution will need to find ways of ensuring that consistency."
Each of the following statements is true about stress testing EXCEPT which is false?
a. Stress testing is a non-statistical risk measure that may employ scenario analysis as one approach
b. An acceptable proxy for stress testing is to generate value at risk (VaR) with a series of progressively increasing confidence levels; e.g., 99.0%, 99.50%, 99.75%, 99.90%, and 99.99%
c. While backtesting validates model parameter(s) using a large number of actual, historical observations; stress testing on the other hand uses a small number of extreme movements in market variables
d. Unlike value at risk (VaR) which indicates neither the magnitude nor shape of extreme losses beyond the VaR threshold, stress testing DOES attempt to characterize the magnitude/shape of the extreme loss tail
800.2. Phillip is developing a "Roles and Responsibilities" framework for his firm's stress testing program. His checklist includes the following key responsibilities:
I. Perform regular reporting of stress-testing results
II. Ensure alignment between firm's risk appetite and stress testing activities
III. Ensure the firm's stress test exercises are all built on identical assumptions and utilize the same information and inputs
IV. Should be at least well-versed, if not expert, in the details of stress testing and be able to drill down to discuss technical details and challenge exercise results on a granular level
Between the board and senior management, who has primary responsibility of the above activities?
a. I. Board, II. Management, III. Both, IV. Both
b. I. Board, II. Management, III. Both, IV. Neither
c. I. Management, II. Management, III. Board, IV. Board
d. I. Management, II. Board, III. Neither, IV. Management
800.3. Zotstreet International is an international financial services firm. The key elements of of its stress testing program include: (i) a governance structure; (ii) policies and procedures; (iii) validation and independent review; and (iv) internal audit. The firm's stress testing policies are approved and annually reassessed by the board. The stress test results are considered directly for decisions relating to capital and liquidity adequacy, including capital contingency plans and contingency funding plan. The firm conducts stress tests internally, under the direction of the Chief Risk Officer (CRO) and her staff in the risk management function, but also retains a third-party vendor to conduct complementary stress tests. The third-party's approach invokes proprietary intellectual capital such that the details of their approach are neither documented nor available for review by Acme, but the summary results are disclosed. Management gives the firm's risk managers (in the risk management function) the flexibility to conduct ad hoc stress tests in order to address rapidly emerging risks and vulnerabilities.
Based on these summary facts, which of the following statements is most TRUE about Zotstreet's stress testing program (best answer please)?
a. Zotstreet appears to have a deficiency with respect to documentation
b. Zotstreet should not be delegating any stress testing to a third party
c. Zotstreet approach appears to generally reflect best practices and include all of the key elements of an effective governance over stress testing
d. Zotstreet approach appears to generally reflect best practices EXCEPT the board should re-assess the firm's stress testing policies at least once per quarter
Answers here:
