The question.
An allocation can appear diversified by asset count while concentrating exposure to the same economic drivers.
The proposed workbench focuses on explaining risks and assumptions. Scenario outputs are conditional analyses, not forecasts or investment recommendations.
The proposed approach.
- Align holdings, returns, benchmarks, and valuation dates
- Compare covariance and factor-risk estimates across windows
- Stress portfolios using explicit historical and hypothetical scenarios
- Study allocations under concentration, liquidity, and turnover constraints
Target architecture.
Holdings and returnsFactor and covariance modelsRisk decompositionScenario engineAllocation studyRisk report
The difficult parts.
- Unstable correlations and covariance estimation
- Incomplete factor histories
- Sensitivity to assumptions about costs and liquidity
How to evaluate it.
- Risk-estimate stability across time windows
- Scenario sensitivity and concentration diagnostics
- Out-of-sample behavior under realistic rebalance costs
Planned deliverables.
- A portfolio and scenario data specification
- A factor and risk decomposition study
- An assumption-aware allocation reporting template
Design principles.
Make the assumptions behind a risk number visible.
A stress test describes a scenario; it does not assign certainty to it.