FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures
A bank compares two stress scenario construction approaches for counterparty exposures: (1) a historical scenario replaying the 2008 crisis moves, and (2) a hypothetical scenario designed by senior management around a plausible geopolitical shock. Which statement is most accurate?
Historical scenarios rest on observed market moves and are easy to justify, but they look backward and can miss new vulnerabilities. Hypothetical scenarios can be tailored to emerging risks and current portfolio concentrations, but they depend on judgment about plausibility and severity.
- AHistorical scenarios are fully objective, so they capture every plausible future risk
- BHypothetical scenarios cannot be quantified and so are unsuitable for exposure limits
- CHistorical scenarios are anchored in observed data but may miss new risks, while hypothetical scenarios can address emerging vulnerabilities but rely on judgmentCorrect
- DHypothetical scenarios are always less severe than historical ones
Explanation
Historical scenarios have the advantage of being realistic and easily explained but are backward looking and may not reflect current portfolio vulnerabilities. Hypothetical scenarios can target current concentrations and emerging risks but depend on expert judgment and plausibility assessment. The other statements overstate or are simply false.
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