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

A bank's ERM team is designing a climate stress test. It considers three scenarios over 30 years: an orderly transition, a disorderly (late and abrupt) transition, and a 'hot house world' with no policy action. Which statement best describes the expected pattern of risks across these scenarios?

A hot house world, with no policy action, carries the highest physical risk, while a disorderly transition carries high transition risk because late, abrupt policy changes force sudden repricing of assets. An orderly transition limits both. The other statements reverse or equate these relationships.

  1. AOrderly transition has the highest physical risk, while hot house world has the highest transition risk
  2. BDisorderly transition has the lowest transition risk because policy is delayed
  3. CHot house world has the highest physical risk, while a disorderly transition has high transition risk because of abrupt policy and repricingCorrect
  4. DAll three scenarios carry identical physical and transition risk, differing only in timing

Explanation

With no policy action, emissions continue and physical damage is greatest while transition risk is small. A late, abrupt transition forces sudden policy and asset repricing, so transition risk is high. An orderly transition spreads adjustment and limits both risks. The other options reverse or equate these relationships.

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