Beyond VaR and Expected Shortfall: The Stress Testing/Scenario Analysis approach for protecting the investors in the post-Covid19 era

Abstract

With political and economic scenarios changing at an ever faster pace, it is necessary to understand the potential effects on asset prices. Today, the topic of rising inflation in the US as well as in the Eurozone, although still considered temporary by central banks, confronts us with the "unexpected risk" of a deviation from the baseline scenario. This implies the risk of having an aggressive monetary policy in the US, in a restrictive direction, therefore harmful to the financial markets. In this context, the question arises: is it possible to contemplate these events beforehand and act in good time? The answer is Yes and good risk management practices are important, using stress testing / scenario analysis techniques to accompany risk measures such as VaR and Expected Shortfall. Implementing this concept, through the implementation of stress test / scenario analysis - Bloomberg Economics Forecast Models® and Bloomberg Factor Models® - the present work seeks to consider plausible adverse scenarios that may arise and to assess the related impacts in terms of portfolio. The final aim is to improve the information set for the investor, allowing him to avoid potential market falls, as far as possible, that could prevent him from achieving his investment objectives.