Which of the following statements are true with respect to stress testing:

Which of the following statements are true with respect to stress testing:

I. Stress testing results in a dollar estimate of losses

II. The results of stress testing can replace VaR as a measure of risk as they are better grounded in reality

III. Stress testing provides an estimate of losses at a desired level of confidence

IV. Stress testing based on factor shocks can allow modeling extreme events that have not occurred in the past
A . I and IV
B . I, II and IV
C . II and III
D . II, III and IV

View Answer

Answer: A

Explanation:

Any stress test is conducted with a view to produce a dollar estimate of losses, therefore statement I is correct. However, these numbers do not come with any probabilities or confidence levels, unlike VaR, and statement III is incorrect. Stress testing can complement VaR, but not replace it, therefore statement II is not correct. Statement IV is correct as stress tests can be based on both actual historical events, or simulated factor shocks (eg, a factor, such as interest rates, moves by say 10-z). Therefore Choice ‘a’ is correct.