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FRM Part II · FRM Exam Part II · Risk Measurement and Assessment

A bank uses scenario analysis alongside its internal loss data to measure operational risk capital. Which is the principal reason scenario analysis is used in addition to internal loss data?

Scenario analysis supplements internal loss data because internal histories seldom contain enough severe, low-frequency events to describe the tail of the loss distribution. It adds forward-looking, plausible extreme events, but it does not remove modelling needs or guarantee lower capital.

  1. AInternal data rarely contain enough severe, low-frequency events to characterise the tail of the loss distributionCorrect
  2. BScenario analysis removes the need for any quantitative modelling
  3. CInternal loss data are always inaccurate in recorded amounts
  4. DScenario analysis guarantees lower capital requirements

Explanation

Severe events are rare, so internal histories are sparse in the tail. Scenarios provide forward-looking, plausible extreme events to supplement the data. They do not eliminate modelling, do not make internal data inherently inaccurate, and are not designed to reduce capital.

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