Stress testing is front page news. The Fed stress tests banks, large institutions stress test their portfolios and now financial advisors are using stress testing for their clients. But like most diagnostic tools, proper stress testing has a complex mathematical background. We make it simple for you. In this video you will learn how portfolio stress testing with a factor model works. And you will be able to explain it to others. With no formulas.
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I really like the covariance matrix analogy – however not so enamoured with statisitcal stress tests as a whole.
When the market drops correlations change a lot (generally get closer to one) as new market information dwarves information about individual companies.
I think you mention something similar elsewhere. Perhaps in the magazine article. Nice blog – keep up the good work!
Yes, correlations changes have been the focus of our team’s research since before 2008. This video explains the problem succinctly (though a bit more quantitatively):