Portfolio Inputs

$ M
Market value of equity holdings
$ M
Market value of bond portfolio
years
Portfolio duration (rate sensitivity)
$ M
Value of credit-sensitive holdings
years
Spread duration for credit losses
%
Equity market decline percentage
bps
Rate change (negative = bond gains)
bps
Spread widening (positive = loss)
$ M
Available loss-absorbing capital
Scenario Quick Reference
Scenario Equity Rates Spreads
Mild Recession -15% -50bp +100bp
Severe Recession -40% -100bp +300bp
2008 GFC Replay -50% -150bp +500bp
Stylized Stagflation -25% +200bp +150bp
Ryan O'Connell, CFA
Calculator by Ryan O'Connell, CFA

Stress Test Results

Total Portfolio Loss -$19,600M FAIL
% Portfolio Loss -12.25%
Post-Stress Value $140,400M
Loss Coverage 76.53%
Scenario Severe

Loss Decomposition

Component Impact Calculation
Equity Loss -$20,000M $50,000M x -40%
Rate Effect +$4,000M $80,000M x 5.0 x -1%
Credit Loss -$3,600M $30,000M x 4.0 x 3%
Total Loss -$19,600M

Portfolio Waterfall

Result Interpretation

Result Coverage Ratio Meaning
PASS ≥ 150% Strong capital adequacy
WARNING 100% - 150% Adequate but thin capital
FAIL < 100% Insufficient capital

Under the Severe Recession scenario, your portfolio would lose $19,600M (12.25%). Your capital cushion of $15,000M covers 76.53% of the projected loss. A Loss Coverage Ratio below 100% indicates insufficient capital to absorb stress losses.

Understanding Portfolio Stress Testing

What is Stress Testing?

Stress testing evaluates how a portfolio would perform under adverse market conditions. Unlike Value at Risk (VaR), which estimates losses at a confidence level under normal conditions, stress tests examine specific extreme scenarios that may not be captured by statistical models.

Key Formulas
Equity Loss: Value x Shock%
Rate Effect: -Value x Duration x Rate Change
Credit Loss: -Value x Spread Duration x Spread Change
Loss Coverage = Capital / |Total Loss|

Key Metrics Explained

  • Equity Shock: The percentage decline in equity values. The 2008 GFC saw S&P 500 decline ~57% peak-to-trough.
  • Rate Shock: Change in interest rates (bps). Negative values mean rates fall, which increases bond prices.
  • Spread Shock: Widening of credit spreads (bps). Investment-grade spreads peaked at ~600bps during 2008.
  • Loss Coverage Ratio: Capital / Total Loss. Values of 150% or higher indicate strong capital adequacy.

Stress Testing vs. VaR

VaR estimates maximum loss at a confidence level (e.g., 99%) under normal market conditions, using historical data or simulations. Stress testing examines losses under specific extreme scenarios that may fall outside normal distributions. VaR answers "What's my worst expected loss on a normal day?" while stress tests ask "What happens if 2008 repeats?" Both are complementary.

Model Limitations: This calculator uses linear stress factors, assumes no portfolio rebalancing, applies uniform credit shocks, and uses duration approximation (first-order only). Actual losses in severe scenarios may exceed model predictions due to liquidity, correlation breakdown, and non-linear effects.

Key Assumptions

  • Linear stress factors applied instantaneously
  • No rebalancing during stress event
  • Historical correlations assumed to hold
  • Duration approximation (first-order sensitivity)
  • Uniform credit spread shock across tiers
  • Credit losses from spread widening only (no defaults)
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Frequently Asked Questions

Stress testing is a risk management technique that evaluates how a portfolio or financial institution would perform under adverse market conditions. Unlike statistical measures like VaR, stress tests apply specific scenarios—either historical events or hypothetical shocks—to understand potential losses. Regulators require banks to conduct stress tests (CCAR, DFAST) to ensure adequate capital buffers.

The key metric is the Loss Coverage Ratio (Capital / Total Loss). A ratio of 150% or higher indicates a Pass—you have ample capital. 100-150% is a Warning—capital is adequate but thin. Below 100% is a Fail—projected losses exceed available capital. Also consider the % portfolio loss: losses exceeding 20-25% may trigger forced liquidations or margin calls.

VaR estimates maximum loss at a confidence level (e.g., 99%) under normal market conditions, using historical data or simulations. Stress testing examines losses under specific extreme scenarios that may fall outside normal distributions. VaR answers "What's my worst expected loss on a normal day?" while stress tests ask "What happens if 2008 repeats?" Both are complementary—VaR for day-to-day risk, stress tests for tail events.

Pre-crisis stress tests failed because: (1) Shock magnitudes were too mild—scenarios assumed 20-30% equity drops when actual declines exceeded 50%; (2) Liquidity risk was ignored—models didn't capture funding freezes; (3) Correlations were assumed stable—in crisis, diversification benefits collapsed as assets moved together; (4) Counterparty risk was underestimated—cascading failures weren't modeled. Post-2008 reforms (Basel III, CCAR) require more severe scenarios.

Duration measures bond price sensitivity to interest rate changes. A portfolio with 5-year duration loses approximately 5% for every 100bps rise in rates. Spread duration measures credit bond sensitivity to spread changes—a 4-year spread duration means 4% loss per 100bps spread widening. In stress scenarios, rates often fall (helping bond prices) while spreads widen (hurting credit). The net effect depends on portfolio composition.

Capital requirements depend on the institution type and regulatory framework. Banks typically target Tier 1 capital ratios of 10-15% of risk-weighted assets. For investment portfolios, the Loss Coverage Ratio should exceed 100% under severe stress—meaning capital covers projected losses. A ratio of 150%+ provides a comfortable buffer. Consider that actual crises often exceed modeled scenarios, so conservative buffers are prudent.

Disclaimer

This calculator is for educational purposes only and should not be used as the sole basis for investment or risk management decisions. The stress scenarios are simplified approximations. Actual market stress events may differ significantly from modeled scenarios. Always consult with qualified financial professionals and conduct comprehensive risk analysis before making investment decisions.

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