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FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction

A bank wants a stress scenario that is both severe and plausible for a portfolio sensitive to many risk factors. Which feature most clearly distinguishes a market-driven scenario from a set of ad hoc single-factor shocks?

A market-driven scenario sets the moves in unshocked risk factors consistently with observed market relationships, so the combined shock is internally coherent and plausible. Ad hoc single-factor shocks can create unrealistic combinations, and judgement is still needed to choose the key variables.

  1. AIt guarantees that the loss is the worst possible outcome of any scenario
  2. BIt shocks every risk factor by the same number of standard deviations
  3. CIt removes the need for any judgement about which key variables to shock
  4. DIt specifies the shock to the other risk factors consistently with observed market correlations, avoiding implausible combinationsCorrect

Explanation

The key benefit is internal consistency: non-shocked factors respond according to estimated relationships, so combinations are realistic. It does not eliminate judgement in picking key variables, does not give the absolute worst loss, and does not apply identical sigma shocks.

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