FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures
A bank's counterparty credit risk team reviews its stress testing framework after a period of market turmoil. Which change best reflects the evolution of counterparty exposure stress testing from the pre-crisis period to current practice?
The best answer is the move from isolated, single-counterparty stresses to portfolio-wide scenarios capturing simultaneous market moves and wrong-way risk. Post-crisis practice is broader and forward-looking, whereas relying on a single VaR figure, only top names or only historical events would leave key risks unmeasured.
- AMoving from stressing only individual counterparties in isolation to also running portfolio-wide scenarios that capture simultaneous market moves and wrong-way riskCorrect
- BReplacing all scenario-based stress tests with a single VaR-based exposure number computed at the 99% level
- CLimiting stress tests to the largest ten counterparties because smaller names cannot affect aggregate exposure
- DRestricting stress tests to historical scenarios so that no hypothetical events are used
Explanation
Pre-crisis practice often looked at counterparties in isolation using limited shocks to market factors. Current practice expects portfolio-level, forward-looking scenarios that capture joint moves of market risk factors, credit quality and wrong-way risk. The other options narrow the scope rather than broaden it.
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