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Scenario Analysis

  • Oct19, 1987 : The Black Monday, a -20 sigma event
  • Sep 1992, breakup of fixed exchange system
    • The 99% VAR would have totally missed the magnitude of actual loss
  • Goals
    • Identify scenarios that would not occur under standard VAR models
    • Simulating shocks that have never occurred
    • Simulating shocks that reflect permanent structural breaks or temporally changed statistical patterns
  • Principles of Scenario Analysis
    • Identify risk factors
    • Forecast and Change Risk factors
    • Revalue Portfolio using VaR system in place
    • Portfolio Vs Event Driven
  • Parallel shift in yield curve
  • Changes in steepness of yield curve
  • Parallel shift in yield curve along with the changes in the steepness of yield curve
  • Changes in yield volatilities
  • Changes in the values of equity indices
  • Changes in equity index volatilities
  • Changes in the values of key currencies with respect to US Dollar
  • Changes in foreign exchange rate volatilities
  • Changes in Swap spreads in G7 countries plus Switzerland

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