1. What scenario analysis is

Scenario analysis answers:

“If this specific set of market moves happens tomorrow, what is the P&L on today’s book?”

Core ingredients:

  1. A base snapshot of risk factors (curves, spreads, FX, vol, etc.).
  2. One or more scenarios: deterministic changes to those factors.
  3. A revaluation engine: reprice portfolio under shocked snapshot.
  4. An aggregation layer: sum and slice results by book, desk, factor.

Scenarios are not probabilities. They are if-then experiments.

2. Types of scenarios

Typical types:

  • Simple factor shocks:
    • “Rates +50 bps parallel”.
    • “Winter power +20 €/MWh, summer −5 €/MWh”.
    • “All FX −10% vs CHF”.
  • Shape / spread scenarios:
    • “Steepen curve: long end +20, short end −10”.
    • “Spark spreads widen by 5 €/MWh”.
    • “Basis between hub A and B doubles”.
  • Composite ‘macro’ scenarios:
    • “Risk-off: equities −10%, credit spreads +100bp, gas +30%, power curves +20€ on winter strips”.

Each scenario is a function:

scenario:base factors→shocked factors \text{scenario}: \text{base factors} \to \text{shocked factors}

Then you re-run valuation.

3. Aggregation and use on a desk

Outputs per scenario:

  • Total P&L for the book.
  • Breakdown:
    • By desk / trader,
    • By product type (vanilla vs structured),
    • By factor set (level, shape, spreads, basis).

Use-cases:

  • Risk limits:
    • “In scenario S, loss must not exceed X.”
  • Risk appetite:
    • Board / senior management want a view under key narratives.
  • Model sanity:
    • Compare scenario P&L to intuition and to historical episodes.

Scenario analysis is where quant pricing meets risk governance.

4. Interview soundbite

“Scenario analysis is deterministic: we take a base snapshot, apply coherent shocks to risk factors, and revalue the entire portfolio. The result is scenario P&L, which we then aggregate by desk, product, and factor. For power/commodities, scenarios must include not just parallel moves, but curve shape shocks, spark/basis spreads, and stress on key seasons like winter strips.”