Understanding the Purpose of Stress Testing in Portfolio Management

Very Easy Risk Management Applications Stress Testing

In the field of portfolio management, stress testing is a vital process used to evaluate how a portfolio would respond to extreme market conditions. Consider a scenario where a portfolio manager wishes to understand the potential impact of a sudden market crash on their investments. By modeling adverse price movements, the manager can assess the vulnerabilities of the portfolio under stress.

Which of the following best describes the purpose of conducting a stress test on a portfolio?

To project future returns of the portfolio under normal market conditions.

To estimate potential losses in the portfolio due to extreme market scenarios.

To optimize asset allocation for maximizing expected returns.

Hint

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