FRM Part I · FRM Exam Part I · Stress Testing
A bank designs a stress scenario for its credit portfolio. Which design choice would most weaken the usefulness of the test for identifying previously unrecognized vulnerabilities?
Relying only on scenarios that replicate past crises weakens the test most. It assumes the next stress will look like earlier ones and can miss new vulnerabilities. Multi-factor shocks, feedback effects and regular scenario review all improve the ability to reveal hidden risks.
- AUsing only scenarios that replicate past crises already experienced by the bankCorrect
- BIncluding scenarios that combine shocks to several risk factors at once
- CConsidering feedback effects between market liquidity and asset prices
- DReviewing scenarios regularly as the portfolio and environment change
Explanation
Relying only on past events assumes the future resembles history and may miss novel vulnerabilities. Combining shocks, adding feedback effects and regular review all make scenarios more forward-looking and more useful. Hence the exclusive use of historical replicas is the weak design.
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