Objective of Stress Testing in Portfolio Management

Medium Risk Management Applications Stress Testing

During a quarterly risk management review, a portfolio manager is analyzing the potential impact of extreme market conditions on the portfolio’s value. The manager employs a stress testing methodology to simulate various adverse scenarios, including a sudden increase in interest rates and a sharp decline in equity prices. Which of the following statements best describes the primary objective of stress testing in this context?

To determine the portfolio's expected returns under normal market conditions.

To identify vulnerabilities and assess the potential impact of extreme market movements on the portfolio.

To estimate the likelihood of extreme market events occurring based on historical data.

Hint

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