What Is a ‘Stress Test’ and How Does It Inform Collateral Requirements?

A stress test is a risk management technique that simulates extreme but plausible market scenarios, such as a sharp price crash or a sudden liquidity freeze, to determine the resulting loss on a derivatives portfolio. The losses calculated from these stress scenarios are used to ensure that the initial margin requirement is robust enough to cover potential losses even beyond the standard VaR calculation.

This informs the collateral requirements by setting a higher floor for the initial margin.