The Benefits of Stress Testing in Risk Management | Cargill

Stress testing is a simulation technique used to evaluate a portfolio against underlying futures price movement. This can help determine portfolio risk and show ... skiptomaincontent Search AboutCargillAboutCargillThriveStoriesCompanyOverviewExecutiveTeam2021AnnualReportOurHistoryCommunityEngagementResearch&DevelopmentDiversity,EquityandInclusionWorkplaceSafetyEthics&ComplianceSupplierCentralSustainabilitySustainabilitySustainableSupplyChainsSustainabilityPrioritiesReportingHubNewslettersignupInnovationthatSustainsProducts&ServicesProducts&ServicesAgricultureAnimalNutritionBeautyBioindustrialCarbonSolutionsFoodserviceFood&BeverageIndustrialPharmaceuticalMeat&PoultryRiskManagementSupplementsTransportationNewsCareers Worldwide Stories Contact Home/Products&Services/RiskManagement/CommodityPriceRisk/ TheBenefitsofStressTestinginRiskManagement   TheBenefitsofStressTestinginRiskManagement  Asnapshot,aphoto,amomentintime–whenyouaremanagingyourrisk,beingabletotestagainstamomentintimeisvital.Inthisarticle,wewillexplorewhyusingstresstestingandValueatRisk(VaR)cansupportyourriskmanagementgoals. Let’sstartwithsomedefinitions Stresstestingisasimulationtechniqueusedtoevaluateaportfolioagainstunderlyingfuturespricemovement.Thiscanhelpdetermineportfolioriskandshowhowmarketpricemovementscouldpotentiallyimpactthatportfolio.Italsohelpsourcustomersidentifymitigatingorstrategicactionsandcontrolsforspecificscenarios. ValueatRisk(VaR)showsthemaximumlossforagivenprobabilityduringacertainperiodoftime.AstresstestisessentiallyanexercisetoexplorehowchangesinmarketconditionsaffectourestimatesforVaR. Aquickoverviewofstresstesting Asmentionedearlier,astresstestcanhelpteachyouhowyourpositionmaybehaveinavarietyofscenarios.AtCargillRiskManagement,weusetwoscenarioswhenweconductastresstestforcustomers.Thetwoscenariosusesimilarmethodologies,andeachisbasedontheunderlyingfuturespricemovement.Here’showthatiscalculated: Determinethepreviousday’sclosingprice Movethatclosingpricetwostandarddeviations,usinganimpliedvolatilityora50-daypublishedhistoricalvolatility,toa95percentdegreeofconfidence. Oncetheunderlyingfuturespricemovementisestablished,wecanperformthescenarioanalyses: Scenario#1:Five-daystressmove Thisgivesusanideaofhowmuchthemarketmightmovewithintheimmediatefive-dayperiod.Thisscenarioassumesthereissomedisciplineinplace,whereyoureviewthesepositionsonaweeklybasis.Thiscouldbeaweeklymeetingoranotherweeklyroutinewhereyouconsiderthescenariostohelpyouproactivelyconsiderhowyouwillactorrebalancedependingonwhathappensduringagivenweek. Scenario#2:PotentialStressMove Thisgivesusanideaofhowmuchthemarketmightmoveoveralongerperiodoftime(untiltheexpirationofpositions)andcanbeconsideredanextreme,yetplausible,scenario. ImpliedvolatilityWH0(@530)=25%? 95%confidencethatthepricewillmovewithin397.50cents/busheland662.50cents/bushel Whystresstestingisimportant Therearemanyfactorsthataffectthemarket–supplyanddemand,cropyieldsandtheassociatedweathertrends,tradewarsandmanymore. Astresstestisagoodexercisetohelpyouandyourteamunderstandyourpositionsandmakedecisionsaboutwhethertokeepmovingforwardwithwhatyouhaveinplaceormakechangestoyourportfolio. AtCargillRiskManagement,stresstestingisonevitalcomponentofbuildingcomprehensivehedgingandriskmanagementdiscipline.Recurringstresstestinghelpsyourteamandcompanygothroughthepacesofdifferentfinancialscenariostoleadeffortstowardsproactiveriskidentificationandactionrecommendations. Thinkaboutthis–whenthemarketgoesagainstyourportfolio,howdoyoucurrentlyaddressit?Thistypeofstresstestinghelpsyouprepareaheadoftimetobeproactiveinsteadoffallingbackontheemotionsthatcanoftenbiasourdecisions.Whenyouhaveaplanaheadoftime,youremovetheemotionalresponsefromtheequationandcanactwithconfidence. CargillRiskManagementisheretohelpyouthinkthroughyourchallengesandneeds–andultimatelyfindtheover-the-counter(OTC)hedgingsolutionsthatcanhelpmanageyourrisk.Weworkwithcustomerstostresstestandeducatethemabouthowtheirportfoliosbehaveandwhatthefuturecouldhold.   ThesematerialshavebeenpreparedbypersonnelintheSalesandTradingDepartmentsofCargillRiskManagement,abusinessunitofCargill,Incorporatedbasedonpubliclyavailablesources,andisnottheproductofanyResearchDepartment.Thesematerialsarenotresearchreportsandarenotintendedassuch.Thesematerialsareforthegeneralinformationofourcustomersandarea“solicitation”onlyasthattermisusedwithinCFTCRules1.71and23.605,aspromulgatedundertheU.S.CommodityExchangeAct.Thesematerialsareprovidedforinformationalpurposesonlyandarenototherwiseintendedasanoffertosell,orthesolicitationofanoffertopurchase,anyswap,securityorotherfinancialinstrument.Thesematerialscontainpreliminaryinformationthatissubjecttochangeandthatisnotintendedtobecompleteortoconstitutealloftheinformationnecessarytoevaluatetheconsequencesofenteringintoaswaptransactionand/orinvestinginanysecuritiesorotherfinancialinstrumentsdescribedherein.Thesematerialsalsoincludeinformationobtainedfromsourcesbelievedtobereliable,butCargillRiskManagementdoesnotwarranttheircompletenessoraccuracy.InnoeventshallCargillRiskManagementbeliableforanyusebyanypartyof,foranydecisionmadeoractiontakenbyanypartyinrelianceupon,orforanyinaccuraciesorerrorsin,oromissionsfrom,theinformationcontainedinthesematerialsandsuchinformationmaynotberelieduponbyyouinevaluatingthemeritsofparticipatinginanytransaction.Allprojections,forecastsandestimatesofreturnsandother“forward-looking”informationnotpurelyhistoricalinnaturearebasedonassumptions,whichareunlikelytobeconsistentwith,andmaydiffermateriallyfrom,actualeventsorconditions.Suchforward-lookinginformationonlyillustrateshypotheticalresultsundercertainassumptions.Actualresultswillvary,andthevariationsmaybematerial.Nothinghereinshouldbeconstruedasaninvestmentrecommendationoraslegal,tax,investmentoraccountingadvice.CargillRiskManagementisaprovisionallyregisteredSwapDealerandoperatesunder“OrderofLimitedPurposeDesignationsforCargill,IncorporatedandanAffiliate.”