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FRM Part II · FRM Exam Part II · Integrated Risk Management

A bank compares two integration approaches. Approach A aggregates capital top-down across risk types using a fixed correlation matrix. Approach B simulates common macroeconomic factors that drive losses in all risk types simultaneously. Which statement is most accurate?

Approach B, which simulates shared macroeconomic drivers, can capture nonlinear and stress-dependent interactions across risk types, while the top-down fixed correlation matrix imposes a static linear dependence that is hard to estimate, especially for operational risk.

  1. AApproach B can capture nonlinear interactions and common drivers, while Approach A relies on a linear, static dependence assumptionCorrect
  2. BApproach A is more accurate because correlations are directly observable for operational risk
  3. CApproach B cannot produce a single loss distribution
  4. DBoth approaches give identical results when the correlation matrix is positive definite

Explanation

Common-factor simulation links risk types through shared drivers and can reflect nonlinear, stress-dependent behaviour. A fixed matrix is linear and static, and cross-risk correlations such as those involving operational risk are hard to observe. Approach B does produce a combined distribution.

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