STRESS TESTING

The process in which investor instead of finding the best performing asset try to find out the asset could withstand the stress in case of failure in the economy. The investor will try to find out a relationship between extend to which asset degrades when the economy degrades to some extend. The will try to find out the impact of the economy failure on the performance of the asset. The economist uses this stress test to identify the best option for the investment. United States of America was using this technique during the economic crisis to find out the stable investment avenue. In this method the modest to extreme level of economic crisis are studied, their corresponding stress factor for the asset is determined. Simulation software’s are available for this purpose.

The investor while investing in an extremely volatile situation must make a careful decision else will end up loosing all the money invested. The stress testing thus helps the investor to understand how safe the investment will be despite the economic turmoil. It is a more of protection tool. It helps the investor to invest in safer investment. It is one of the important risk management techniques. This method however cannot be used when there is a sudden dramatic economic change. Stress testing is usually used to analyze marketing risk and their impact on the stock. Some of the factors that are considered during the analysis are interest rate, foreign exchange and other commodity based risks.

Stress testing classification is of two types they are

• Sensitivity test analysis the stress due to a large movement in the financial variables. This test cannot be used on a long term basis.  
• Scenario test is the test in which the managers identify the key factors influencing the portfolio and calculate the stress of the portfolio for these variables. 

The stress testing gives the risk management team with additional information of the possible risk factors and extend to which they might cause damage to the portfolio. This calculation can be used as a tool to convince the outsiders. These outsiders include investor, bankers etc. The investor will be overwhelmed and ready to invest if the stress testing result are quite positive.