What is a scenario analysis?

Scenario analysis is the process of estimating the expected value of a portfolio over a period of time, assuming specific changes in the value of portfolio securities or key factors, such as changes in interest rates. Scenario analysis is typically used to estimate changes in portfolio value in response to an adverse event and can be used to study a theoretical worst-case scenario.

Key exports

Scenario analysis is the process of estimating the expected value of a portfolio after a certain change in the values of key factors has taken place.

Probable scenario, and hardly the worst events can be verified in this way, often based on computer simulations.

Scenario analysis can be applied to both investment strategy and corporate finance.

Special considerations


Scenario analysis and investment strategy





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How script analysis works

As a methodology, scenario analysis involves calculating different reinvestment ratios for the expected return that is reinvested within the investment horizon. Based on mathematical and statistical principles, scenario analysis provides a process for estimating changes in portfolio value based on the occurrence of various situations, referred to as scenarios, guided by the principles of what-if analysis.

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These estimates can be used to examine the amount of risk that exists within a particular investment associated with a variety of potential events, ranging from high probability to very unlikely. Depending on the results of the analysis, the investor can determine whether the level of risk is in his comfort zone.



One type of scenario analysis that specifically considers worst-case scenarios is stress testing. Stress testing is often used with computer simulations to test the resilience of institutions and investment portfolios against possible future emergencies. Such testing is typically used by the financial industry to assess investment risk and asset adequacy, as well as to assess internal processes and controls. In recent years, regulators have also required financial institutions to conduct stress tests to ensure the adequacy of their capital and other assets.

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There are many different ways to approach scenario analysis. A common method is to determine the standard deviation of the daily or monthly returns of securities, and then calculate what value is expected for the portfolio if each price of the securities generates returns that are two to three standard deviations above and below the average return. Thus, the analyst can have enough confidence to change the value of the portfolio over a period of time, simulating these extremes.





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The scenarios considered may relate to a single variable, such as the relative success or failure of a new product launch, or a combination of factors such as product launch results combined with possible changes in competitors' performance. The goal is to analyze the results of more extreme results to determine the investment strategy.



Analysis of scenarios of personal and corporate finances

The same process used to study potential investment scenarios can be applied to various other financial situations in order to study value changes based on theoretical scenarios. For consumers, a person can use scenario analysis to examine the different financial results of purchasing an item on credit, as opposed to saving money on purchasing cash. In addition, a person may consider various financial changes that may occur when deciding to accept a new job offer.





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Businesses can use an analysis scenario to analyze the potential financial results of certain decisions, such as choosing one of two objects or showcases from which a business could operate. This may include considerations such as the difference in rent, utilities and insurance, or any benefit that may exist in one place and not in another.

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