Question

21.Which of the following statements about stress testing are true? I. Stress testing can complement VaR estimation in helping risk managers identify how vulnerable a portfolio might be to a variety of extreme events. II. Stress tests cannot be used in VaR estimates. III. Random combinations of stress shocks could be inconsistent with the basic laws of economics. IV. The inclusion of a large number of scenarios helps management better understand the risk exposure of a portfolio. I and III only II and IV only I, III, and IV only I, II, III, and IV

Answer 1

I, III, and IV only

Stress testing complement VaR estimation. This does helps portfolio managers in estimating vulnerability. Hence, I is true. Basic law of economics states that certain combination of macro economic events cannot occour together. When random combinations of stress tests are considered, these laws are violated. Hence, III. is true. Statement IV is also true as more the number of scenarios, better is the prediction and better understanding of the risk exposure.

Statement II i false as various VaR methods depends on stress testing like Monte carlo simulation, parametric VaR etc.