A risk management technique that evaluates how financial portfolios or institutions would perform under adverse economic scenarios, such as market crashes, interest rate spikes, or economic recessions. It helps identify vulnerabilities and ensure adequate capital reserves.
Borrowed from engineering, where 'stress testing' meant subjecting materials to extreme conditions to find breaking points. Financial stress testing gained prominence after the 1970s oil crises and became mandatory for major banks following the 2008 financial crisis.
Stress testing is like putting your financial portfolio through boot camp - you throw the worst possible scenarios at it to see if it can survive without breaking! The Federal Reserve now requires big banks to pass annual stress tests that simulate scenarios like unemployment hitting 10% and stock markets falling 50%, ensuring they can weather another 2008-style crisis.
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