Stress testing (portfolio).

In plain English

Portfolio stress testing applies a defined extreme event, such as a sharp equity decline or a rate spike, to current holdings and calculates the resulting loss position by position. Tests can replay historical episodes or use hypothetical shocks built from scratch. Unlike value at risk, a stress test does not attach a probability to the scenario; it simply asks what would happen if the scenario occurred. Good tests move several variables at once, because in a crisis stocks, credit spreads, and correlations rarely move in isolation. Regulators require formal versions for large banks, and the same logic scales down to a household portfolio.

01Why it matters

Knowing the dollar loss in a severe scenario before it happens is what makes it possible to decide in advance whether that loss is survivable.

02The math, step by step

A 500,000 portfolio holds 70 percent stocks and 30 percent investment-grade bonds. Apply a shock of stocks down 35 percent and bonds down 5 percent. Stocks lose 0.70 times 500,000 times 0.35, or 122,500. Bonds lose 7,500. Total loss is 130,000, or 26 percent of the portfolio.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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