Chapter 13: Back‑Testing and Scenario Analysis

In this section

• Principles of Back‑Testing in Finance
  Discover how to evaluate trading strategies and risk models using historical data, avoid overfitting, and interpret performance metrics for robust investment decisions.
• Scenario Analysis for Risk Assessment
  Explore how scenario analysis helps identify potential outcomes, portfolio vulnerabilities, and non-linear risks by examining best-, worst-, and base-case scenarios, incorporating both quantitative data and qualitative judgment.
• Stress Testing Portfolio Performance
  Explore how extreme yet plausible market shocks can affect portfolios, assess capital buffers, and fulfill regulatory requirements through practical stress testing techniques.
• Limitations and Pitfalls of Model‑Based Testing
  Explore the challenges of relying on historical and model-based approaches in back-testing and scenario analysis, including overreliance on stable data, incorrect assumptions, and the dangers of selective scenarios.
• Historical Simulation Approaches
  Explore how historical simulation uses real-world return data to capture extreme events, inform risk metrics like VaR and CVaR, and guide portfolio risk management decisions.
• Extending Scenario Analysis to Macroeconomic Stress
  Expand your scenario analysis framework by capturing broad economic shocks, dynamic interactions, and policy responses in advanced macroeconomic stress testing.