Key Considerations in Stress Testing Interpretation

Very Hard Risk Management Applications Stress Testing

A portfolio manager is evaluating the risk exposure of a diversified equity portfolio worth $50 million, which includes various sectors such as technology, healthcare, and consumer goods. To prepare for potential future crises, the manager intends to conduct stress testing against historical market shocks and hypothetical scenarios.

One of the hypothetical scenarios involves a sudden increase in interest rates by 200 basis points, coupled with heightened geopolitical tensions that may affect global market sentiment. Based on these factors, the manager aims to assess the worst-case impact on the portfolio's value.

Given the context and the characteristics of stress testing, which of the following statements best represents a key consideration when interpreting the results of the stress test conducted on the equity portfolio?

Stress tests should always reflect actual historical experiences and cannot incorporate hypothetical scenarios.

The results of stress testing are valid only if the portfolio's historical performance aligns with the stress scenarios applied.

Stress testing results must be interpreted within the context of portfolio composition, risk factors, and institutional objectives.

Hint

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