FRM Part I · FRM Exam Part I · Stress Testing
A bank runs a reverse stress test. Which description correctly characterizes it and its main use in risk management?
A reverse stress test starts from a predefined unacceptable outcome, such as insolvency or a liquidity breach, and identifies the scenarios that could produce it. It helps management uncover hidden vulnerabilities and concentrations that forward-looking scenarios chosen in advance may overlook.
- AIt starts with a defined adverse scenario and projects the resulting loss, used mainly to calibrate VaR confidence levels
- BIt starts with a predefined outcome such as insolvency or a breach of the liquidity limit and identifies the scenarios that could cause it, helping reveal hidden vulnerabilitiesCorrect
- CIt reruns past stress tests using reversed signs on all risk factors to test model symmetry
- DIt back-tests the bank's VaR model by counting exceptions over a one-year window
Explanation
Reverse stress testing begins from an unacceptable outcome, such as failure or breach of a critical threshold, and works backward to find the combinations of events that would produce it. This exposes vulnerabilities that forward scenarios may miss. The first option describes ordinary scenario analysis; the others are unrelated.
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