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Modeling Future Shocks: MSCI Best Practices for Predictive Stress Testing

The aftermath of the 2008 global financial crisis taught the risk industry that expert judgment and economic insight may help investors anticipate and avoid exposure to major financial downturns by using forward-looking models, such as predictive stress tests. But there is no consensus on how to create these scenarios. In this paper, we portray MSCI best practices for stress testing in a flowchart that guides risk managers through a series of steps that lead to a structured way of stress testing portfolios by first describing the scenario quantitatively, and then propagating the shockwave onto all relevant risk factors of an actual portfolio.