Stress-Testing Portfolio-Specific Risk

Jason D. Fink, Kristin E. Fink and Hui H. Sono

Volume 11, Number 4, Fourth Quarter 2013

We establish a relationship between the idiosyncratic risk of portfolios and a parsimonious group of market variables. Because we are able to summarize idiosyncratic risk with this small group of variables, we are able to design stress-tests that describe portfolio-specific risks as market variables change. These stress tests provide portfolio managers with important information that cannot be gleaned from standard volatility forecasts.