Fat Tails and Extreme Events [32]

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Bullet points include: There are several types of stress test each with different nuances: Analysis of impact on portfolio (or firm) of movements in specific market drivers, within an envelope of the plausible range of outcomes. Specific industry-wide stresses mandated by the regulator (e.g. used in capital computations). A focus on configurations of events that might lead to large losses (e.g. reverse stress testing). Some commentators encourage us to revert to a more statistical emphasis when choosing stress tests. Challenge: portfolio construction must ultimately trade off risk versus reward, so needs to include some link back to likelihood of occurrence

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