Algorithm for Scenario approach
Scenario approach estimates possible outcomes on the basis of expert assessments. In comparison to sensitivity analysis, several risk factors are considered at a time (multiattribute stress tests).
Choice of the changing factors may be performed on the basis of historical data as well as hypothetical scenarios. The advantage of this type of a stress test is a more flexible formulation of possible events.
Algorithm for Scenario approach:
- Set the number of considered scenarios and probability for each of them
- Choose the set of variables (risk factors)
- On the basis of expert assessment define values of chosen factors for each scenario
Form of paramaters settings
On the bases of the calculated values for each scenario we can draw a distribution function for the analyzed resulting value (assuming a normal distribution law).
Now some qualitative risk assessment is possible as well. For example, one can calculate Value-at-Risk (VaR) – a measure of maximum exposure to losses with a set probability.
Calculation results in the Excel sheet
Despite the simplicity and attractiveness of such an approach, it does not consider correlation between risk factors, resulting in incorrect outcomes.