Zachary J483 Lee#2

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What is stress VaR (Value-at-Risk) and how is it used in trading?

Stress VaR extends traditional VaR by simulating portfolio losses under extreme but plausible scenarios, such as 2008-style volatility or sudden FX peg breaks. Unlike standard VaR, which uses historical volatility and correlations, stress VaR overrides inputs with crisis conditions. Example: a bank holding EUR/USD and USD/CHF might model a 10% sudden move if the SNB repegs the franc. Benefits: identifies vulnerabilities not visible in calm data, satisfies regulatory requirements (Basel accords), and helps size hedges. Risks: assumptions matter—too mild and risks are underestimated, too severe and results may paralyze trading. Institutions run stress VaR daily, comparing actual positions with regulatory limits. For retail, simple adaptations include simulating worst historical weeks on your strategy. Stress VaR doesn’t predict the future; it reveals how fragile or resilient a portfolio may be if chaos returns.