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What is Sensitivity Analysis?

Sensitivity Analysis is a technique used by financial analysts to gauge the impact on the outcomes of a model that may be caused by changes in assumptions or circumstances.

What is a Model?
In finance, a portfolio model is created with the use of mathematical equations that demonstrate the relationships between different financial instruments and markets with each other. These mathematical equations can also tie in concepts such as cash flow with accounting terms such as accrual accounting. The goal of a model is to accurately predict future performance. However, models are never perfect. They tend to be close to perfect in most situations, but not quite accurate enough. It is up to the investor or anyone using the model to decide if they are willing to accept a slight amount of error for some amount of accuracy. Many people may use different models for different purposes, such as risk versus return versus capital versus liquidity versus credit versus accounting versus tax-efficiency. A portfolio model usually looks at all these variables and then determines how much one should invest in each asset class (i.e., equity, debt, real estate, etc.). The model is adjusted over time as well so that the investor can take advantage of changing market conditions. This is where the sensitivity test comes into play.

How Can You Calculate Sensitivities?
There are many ways to calculate sensitivities, but there are two main ways used by investors: proxy testing and simulation. These are explained in greater detail below.
Proxy Testing with a Portfolio Model
For proxy testing, one looks at the historical data to see how sensitive an asset class or market was to one variable versus another. For example, if I wanted to know how sensitive the stock market was to interest rates , I could look at historical data for this relationship . To find this relationship, I would first find the equation of the model that tells me I need to have a certain amount of stock in my portfolio for each % change in interest rates . For example, if my model is correct and I need to have 0.50% of my portfolio for every 1% decrease in interest rates , I would divide 100 by 0.500 to get 5. If there are not enough stocks traded during this time period, you could also use other methods such as different time periods or using different average interest rates.
Once you’ve found your new equation, you can plug it into x = 100/x shows you how sensitive the price of an individual stock is to changing interest rates .

Example of Simulation with a Portfolio Model
For simulation with portfolio models, one uses the model to simulate different variables until it can accurately predict an outcome. This is useful for use in scenario analysis . To do this, one creates a new model that incorporates the variables you want to test. One then runs predictions on this new scenario versus the old scenario to see how effective it is at predicting an outcome.
Example of Simulation with Financial Instruments
For simulation with financial instruments, one uses the model to simulate different variables until it can accurately predict an outcome. This is useful for use in scenario analysis . To do this, one creates a new model that incorporates the variables you want to test.

Types of Sensitivity Analysis

There are four major types of sensitivity analyses: Monte Carlo simulation, Perturbation analysis, Sensitivity Table, and Marginal Analysis. Each has its own advantages and disadvantages so let’s go over them one-by-one.

Monte Carlo simulations (also known as Monte Carlo analysis) is a technique used to find the genetic relationships between items in a multi-level model. It uses random numbers generated from a probability distribution and then runs the model thousands of times to get the probabilities. It can tell you what will happen if we change our assumptions or we change the parameters used in the model and evaluate how sensitive each result would be to different changes.

Perturbation analysis is based on either assuming that parameters are not correlated, or assumptions about independence. Sensitivity analysis examines how sensitive all variables are to changes in assumptions or circumstances. It estimates the impact of changes on the values of variables. There are different approaches, including (1) sensitivity analysis using a probability or sensitivity table, (2) marginal or partial methods of sensitivity analysis, which estimate relationships between future values and current values, and (3) probabilistic sensitivity analysis where probabilities can be calculated for all combinations of estimated parameters.

A Sensitivity Table is a table of numbers used to estimate the effect that changes in parameters have on model outputs. A marginal approach is just that–a marginal approach which focuses on the relationship between the effect of parameter changes on outputs and imputed inputs using imputations to estimate parameter ranges. The imputed inputs are essentially dummy variables related to variation in parameters. The sensitivity analysis approach is taken when there is no information about the exact relationships between the parameters and outputs.

In Sensitivity Analysis in finance, a fully connected model with a continuous time lag is used to simulate a financial strategy using Markov Chain Monte Carlo (MCMC) software. Observations at time t are used to estimate parameters at time t+1, which in turn are used to simulate future outcomes given these parameters. The impact on future outcomes of changing assumptions or parameter values can be found by running the model many times and looking at which results meet certain criteria such as statistical significance or how sensitive they are to changes in assumptions and parameter values. This knowledgeability helps us support our risk management strategies for larger investment portfolios.

Sensitivity analysis can basically be performed to find out how changes in input variables affect the final result. Specifically, one has to measure how uncertainties or randomness in input variables affect the final results. The idea is that if you are not sure about something now, then you should probably take into consideration all possible outcomes so that you know exactly what could happen were things turn out differently than expected. Fintalent, the hiring and collaboration platform for tier-1 M&A and Strategy professionals offers business managers a platform to hire Expert Freelance Financial Analysts to help businesses meet all of their Sensitivity Analysis needs in other to secure their profitable existence.

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Frequently asked questions

Most frequent questions and answers

What clients usually engage your Sensitivity Analysis Consultants?

We work with clients from all over the world. Our clients range from enterprise and corporate clients to companies that are backed by Private Equity or Venture Capital funds. Furthermore, we work directly with Family Offices, Private Equity firms, and Asset Managers. Most of our enterprise clients have dedicated Corporate Development, M&A, and Strategy divisions which are utilizing our pool of Sensitivity Analysis talent to add on-demand and flexible resources, expertise, or staff to their in-house team.

How is Fintalent different?

Fintalent is not a staffing agency. We are a community of best-in-class Sensitivity Analysis professionals, highly specialized within their domains. We have streamlined the process of engaging the best Sensitivity Analysis talent and are able to provide clients with Sensitivity Analysis professionals within 48 hours of first engaging them. We believe that our platform provides more value for Corporates, Ventures, Private Equity and Venture Capital firms, and Family Offices.

Our Hiring Process – What do ‘Community-Approach’ and ‘Invite-to-Apply’ mean?

‘Invite-to-Apply’ is the process by which we shortlist candidates for the majority of projects on our platform. Often, due to the confidential nature of our clients’ projects, we do not release projects to our whole platform but using the matching technology and expertise of our internal team we select candidates who are the best fit for our clients’ needs. This approach also ensures engagement with our community of professionals on the Fintalent platform, and is a benefit both to our clients and independent professionals, as our freelancers have direct access to the roles best suited to their skills and are more likely to take an interest in a project if they have been sought out directly. In addition, if a member of our community is unavailable for a project but knows someone whose skill set perfectly fits the brief, they are able to invite them to apply for the role, utilizing the personal networks of each talent on our platform.

Which skills and expertise do your Fintalents have?

The Fintalents are hand-picked and vetted Sensitivity Analysis professionals, speak over 55 languages, and have professional experience in all geographical markets. Our Sensitivity Analysis consultants’ experience ranges from 3+ years as analysts at top investment banks and Strategy consultancies, to later career C-level executives. The average working experience is 6.9 years and 80% of all Fintalents range from 3-12 years into their careers.

Our Sensitivity Analysis consultants have experience in leading firms as well as interfacing with clients and wider corporate structures and management. What makes our Sensitivity Analysis talent pool stand out is the fact that they have technical backgrounds in over 2,900 industries.

How does the screening and onboarding of your Sensitivity Analysis talent work?

Fintalent.io is an invite-only platform and we believe in the power of referrals and a closed-loop community. Members of our community are able to invite a small number of professionals onto the platform. In addition, our team actively scouts for the best talent who have experience in investment banking or have worked at a global top management consultancy. All of our community-referred talent and scouted talent are subject to a rigorous screening process. As such, over the last 18 months totaling more than 750 hours of onboarding calls, of which only 40% have received an invite-link after the call.

What happens if I am not satisfied with my Sensitivity Analysis consultant’s work?

During your initial engagement with a member of our Fintalent talent pool with no risk. If you are not satisfied with the quality of your hire for any reason then we are able to find a replacement at short notice. There is no minimum commitment per project, but generally projects last at least 5 days and can last 12+ months.

Interested in our invite-only community of tier-1 Sensitivity Analysis experts?

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