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<p>We propose a method for developing stress testing scenarios based on information embedded in the market prices of actively traded options. Our approach relies on techniques for extracting the probabilities of possible future tail events from option prices, and uses those probabilities as a measure of plausibility. Distributional methods may result in unreliably low probabilities of severe scenarios due to data limitations. Scenarios based on expert-judgment methods commonly lack assigned probabilities, making it difficult to assess their plausibility. Our option-based approach complements existing methods based on historical distributions or expert judgment and provides a tool for evaluating the plausibility of hypothetical shocks that are more severe than the historical experience.</p>

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Market Shock Scenario Design: An Option-Based Approach

  • 期刊论文

  • 发表日期：

    2025年5月14日

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  • Azamat Abdymomunov,
  • Zheng Duan,
  • Jeffrey R. Gerlach

摘要

We propose a method for developing stress testing scenarios based on information embedded in the market prices of actively traded options. Our approach relies on techniques for extracting the probabilities of possible future tail events from option prices, and uses those probabilities as a measure of plausibility. Distributional methods may result in unreliably low probabilities of severe scenarios due to data limitations. Scenarios based on expert-judgment methods commonly lack assigned probabilities, making it difficult to assess their plausibility. Our option-based approach complements existing methods based on historical distributions or expert judgment and provides a tool for evaluating the plausibility of hypothetical shocks that are more severe than the historical experience.