Stress Testing Vs Scenario Analysis Vs Backtesting

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Hi David,

I just want to get a clearer understanding of these 3 concepts.
What are the differences amongst these 3 concepts stress testing, scenario analysis and backtesting?
Under what circumstances that they are used?
Under what circumstances that they are not appropriate to be used?

This is "inspired" by the following 2006 FRM past year question
which of the following is true about stress testing?
a) It is used to evaluate the potential impact on the portfolio of unlikely, although plausible, events or movements in a set of financial variables. -------------This is the answer given.
b) It is a risk management tool that directly compares predicted results to observed actual results. Predicted values are also compared with historical data. ------------I think this is backtesting
c) Both 'a' and 'b' are true
d) None of the above are true.

Thanks
Learning

 

[David Harper CFA FRM]

Hi Learning,

I am still looking for a glib, concrete distinction between stress testing and scenario analysis
here is my perspective on stress test versus scenario analysis: http://forum.bionicturtle.com/url goes here/viewthread/1671/#3453
e.g., Jorion classifies SA under stress testing

so, as far as i am concerned, SA is a tool within stress testing and Stress testing is a key complement to VaR in assessing risk, etc

Basel II IMA market risk requires both stress test and backtest...

...backtest has a specific meaning, and it is made concrete in Basel's red/yellow/blue traffic light
...also, Jorion Chapter 6
...and I think the following question is very instructive practice:
http://forum.bionicturtle.com/viewthread/1409/

so the backtest (in the case of VaR) is to, ex post, compare the actual VaR exceedences to the expected. Backtest is a test of model's accuracy where, owing to statistics, we cannot perfectly say "good model" or "bad model" but we can, as usual, specify the probability of Type I/II errors.

I hope that helps, David

 

[madhuaryal]

David,

I wanted to read your article on Stress Testeing vs. Scenario Analysis. Please let me look at it, kindly send me the link.

Cheers, Madhu

 

[sarita]

Hi David,

how are you doing? i was looking at the reply that you gave below and clicked on the link provided to see your perspective on stress test vs scenario analysis - unfortunately, i was not able to find it. it just took me to the general forum.

Would you kindly let me know where i can see your perspective on the SA and ST?

Thanks,

S



=====================================================
I am still looking for a glib, concrete distinction between stress testing and scenario analysis
here is my perspective on stress test versus scenario analysis: http://forum.bionicturtle.com/url goes here/viewthread/1671/#3453
e.g., Jorion classifies SA under stress testing

 

[David Harper CFA FRM]

Hi Saray,

I'm doing well, I hope your studies are going well. Thank link should be:
http://forum.bionicturtle.com/viewthread/1671/#3453

Cheers, David

 

[sarita]

Many thanks for the quick response David.
Best,
S