How Do Stress Tests Help Determine the Adequacy of a Default Waterfall?

Stress tests are crucial for assessing the adequacy of a default waterfall by simulating how it would perform under extreme market conditions. These tests model severe price shocks, volatility spikes, and member defaults to quantify potential losses.

By comparing these potential losses to the available financial resources in each layer of the waterfall, the clearing house can determine if the waterfall is robust enough. The results of stress tests are used to calibrate the size of the default fund and ensure the clearing house meets regulatory requirements for resilience.