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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A bank uses a scenario-analysis approach for climate risk over a 30-year horizon, whereas its standard credit models use a one-year horizon calibrated to historical data. Which is the best justification for relying on forward-looking scenarios here?

Forward-looking scenarios are justified because climate risk involves structural, unprecedented change that historical data may not capture, so history-calibrated one-year models can understate long-term losses. Scenarios explore plausible paths rather than giving exact probabilities, and they still require governance oversight.

  1. AHistorical data may not reflect structural, unprecedented climate-driven changes, so past distributions are a poor guide to future lossesCorrect
  2. BScenarios produce exact probabilities of future losses
  3. COne-year models are always inferior to long-horizon models
  4. DScenario analysis removes the need for governance oversight

Explanation

Climate risk involves non-stationary, unprecedented change with deep uncertainty, so history-calibrated models may understate risk. Scenarios explore plausible paths but do not give exact probabilities, and governance is still required.

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