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FRM Part II · FRM Exam Part II · Stress Testing Banks

A bank designs a stress scenario by first specifying a severe macroeconomic path (GDP fall, unemployment rise, house price decline) and then translating it into losses on each portfolio. How is this approach best classified?

This is macroeconomic scenario analysis. The bank defines a coherent economic narrative first and then translates it into portfolio losses. A reverse stress test works the other way, starting from a failure outcome and identifying what scenarios cause it, while sensitivity analyses shock individual risk factors.

  1. AReverse stress test
  2. BFactor-push sensitivity analysis
  3. CSingle-factor shock to a market variable
  4. DMacroeconomic (top-down narrative) scenario analysisCorrect

Explanation

Starting from a coherent macroeconomic narrative and mapping it to portfolio losses is macro scenario analysis. A reverse stress test starts from a defined adverse outcome, such as insolvency, and searches for the scenarios causing it. Single-factor and factor-push approaches move individual variables rather than a coherent economic story.

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