Definition of 'Scenario Analysis'
The process of estimating the expected value of a portfolio after a given period of time, assuming specific changes in the values of the portfolio's securities or key factors that would affect security values, such as changes in the interest rate.
Scenario analysis commonly focuses on estimating what a portfolio's value would decrease to if an unfavorable event, or the "worst-case scenario", were realized. Scenario analysis involves computing different reinvestment rates for expected returns that are reinvested during the investment horizon.
Investopedia explains 'Scenario Analysis'
There are many different ways to approach scenario analysis, but a common method is to determine what the standard deviation of daily or monthly security returns are, and then compute what value would be expected for the portfolio if each security generated returns two or three standard deviations above and below the average return.
In this way, an analyst can have reasonable certainty that the value of a portfolio is unlikely to fall below (or rise above) a specific value during a given time period.