A Sensitivity-Based Model is an analytical framework that quantifies how the value or performance of a financial instrument, portfolio, or system changes in response to specific variations in underlying market factors or input parameters. Its purpose is to assess risk exposure and understand the impact of hypothetical changes on system outputs.
Mechanism
The operational mechanism involves systematically altering one or more input variables—such as interest rates, exchange rates, asset prices, or volatility—while holding others constant, then recalculating the model’s output. This process generates a set of sensitivities (e.g., “Greeks” for options) that indicate the magnitude and direction of the change.
Methodology
The strategic approach utilizes these sensitivities to manage risk, optimize hedging strategies, and perform scenario analysis. This methodology allows for the identification of critical dependencies and vulnerabilities within a financial system or investment portfolio. It provides a structured means to evaluate potential outcomes under various market conditions, informing risk budgeting and stress testing.
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