Stress Testing

DEFINITION of 'Stress Testing'

A simulation technique used on asset and liability portfolios to determine their reactions to different financial situations. Stress tests are also used to gauge how certain stressors will affect a company or industry. They are usually computer-generated simulation models that test hypothetical scenarios.

This is also known as a "stress test".

BREAKING DOWN 'Stress Testing'

Stress testing is a useful method for determining how a portfolio will fare during a period of financial crisis. The Monte Carlo simulation is one of the most widely used methods of stress testing.

A stress test is also used to evaluate the strength of institutions. For example, the Treasury Department could run stress tests on banks to determine their financial condition. Banks often run these tests on themselves. Changing factors could include interest rates, lending requirements or unemployment.

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